Accounting  Students'  Series 

ACCOUNTING  PRINCIPLES.  By  Samuel  F.  Racine,  C.  P. 
A.  |3.00.  A  text  written  expressly  for  the  advanced  stu- 
dents of  one  of  the  leading  schools  of  the  West.  It  is  the 
one  book  on  accounting  principles  to  which  the  student 
can  refer  and  find  an  answer  to  any  of  the  baffling  ques- 
tions on  the  theory  of  accounts.  Every  published  exami- 
nation paper  of  recent  years  was  carefully  studied  in  an 
effort  to  bring  all  their  salient  features  into  this  unusual 
book.  Depreciation,  Goodwill,  Reserves  and  Sinking 
Funds  receive  the  careful  attention  they  so  justly  deserve. 

STUDENTS'  GUIDE  TO  THE  STUDY  OF  AUDITING.  By 
Samuel  F.  Racine,  C.  P.  A.  fl.OO.  A  careful  analysis 
of  the  leading  text  book  on  auditing  arranged  in  ques- 
tion form  for  the  purpose  of  facilitating  study.  Every 
page  of  the  text  book  was  carefully  analyzed  and  special 
questions  were  prepared  to  bring  out  each  important 
point  mentioned  so  that  the  student  is  guided  directly 
to  the  particular  information  he  should  secure  from 
each  chapter  and,  by  endeavoring  to  answer  the  questions 
after  completing  a  chapter,  can  readily  determine  the  re- 
sult of  his  effort.  Instructors  and  students  who  are 
using  this  book  find  it  invaluable. 

STUDENTS^  GUIDE  TO  THE  STUDY  OP  ACCOUNTING.  By 
Samuel  F.  Racine,  C.  P.  A.  fl.OO.  A  book  similar  to 
the  Guide  to  the  Study  of  Auditing  but  containing  care- 
fully chosen  questions  on  a  number  of  the  leading  text 
books  on  general  accounting  and  cost  accounting.  It 
also  contains  a  number  of  problems  and  solutions  illus- 
trating the  subject  matter  of  the  text  books  used. 

GRADED  CORPORATION  PROBLEMS.  By  Samuel  F. 
Racine,  C.  P.  A.  $1.25.  A  series  of  problems  chosen 
from  the  Certified  Public  Accountants'  examination 
questions,  classified  according  to  subject  and  carefully 
graded. 


Accounting  Students'  Series 


Guide  to  the  Study  of 
Auditing 


By 
SAMUEL   F.   RACINE 

\    : 

Certified  Public  Accountant 


1914 


vtf 


Copyright  1914  by 
Samuel  F.  Racine 


Published  by 

The  Western  Institute  of  Accountancy,  Commerce  and  Finance 
Leary  Building,  Seattle 


of 

Lowman  &  Hanford  Co. 
Seattle,  Wash. 


AUDITING 
THEORY  AND  PRACTICE 


By 
Robert  H.  Montgomery,  C  P.  A. 


PUBLISHED  BY 
THE  RONALD  PRESS  CO. 

NEW  YORK 


Price  $5.00 


1913 


AUDITING  THEORY  AND  PRACTICE 

Montgomery 


CHAPTER  I. 
PURPOSE  OF  THIS  BOOK. 

1.  What   constitutes   a   scientific   system   of   ac- 
counts? 

2.  Into  what  branches  may  accountancy  be  di- 
vided? 

3.  Outline  the  salient  features  of  the  report  on 
the  financial  condition  of  "A"  and  "B"  Co. 

5.  Outline  the  working  of  the  subsidiary  plant 
ledger  mentioned.  In  what  way  is  it  like  the  general 
books?  What  is  the  usual  tendency  of  insolvent  con- 
cerns in  regard  to  the  valuation  of  assets?  Why  is 
it  desirable  to  show  the  provision  for  depreciation 
separate  from  the  machinery  account?  How  is  con- 
servatism in  valuations  supposed  to  affect  the  bor- 
rowing power  of  a  concern? 

CHAPTER  II. 

PURPOSES  AND  ADVANTAGES  OF  AN  AUDIT. 

8.  How  do  you  account  for  the  failure  of  so  many 
persons  to  employ  auditors? 

9.  What  are  the  purposes  of  an  audit? 

11.  What  is  the  responsibility  of  an  auditor  in 
connection  with  the  detection  of  fraud?     What  are 
the  principal  avenues  of  fraud?    How  may  fraud  be 
practiced  by  the  mis-appropriation  of  cash  or  goods? 

12.  Explain  how  accounts  may  be  manipulated  to 
benefit  an  employee  of  a  concern  or  to  deceive  bankers, 


8  GUIDE   TO  THE   STUDY   OF  AUDITING 

creditors  or  stockholders.     What  particular  types  of 
errors  should  the  auditor  watch  for? 

13.  What  are  the  most  common  errors  from  prin- 
ciple? 

14.  How  may  they  be  detected? 

15.  Is  it  advisable  for  an  auditor  to  devote  his 
time  to  the  location  of  clerical  errors?     What  con- 
stitutes an  error  of  omission?    Do  such  errors  affect 
the  trial  balance?    What  are  the  most  common  ones 
and  how  should  an  auditor  proceed  to  locate  them? 

16.  What   constitutes    an    error    of   commission? 
What  constitutes  an  "offsetting  error"? 

18.  Outline  the  advantages  of  an  audit  and  the 
advantages  accruing  through  an  accurate  statement 
of  the  condition  of  a  firm. 

19.  Wherein    does   a   banker    profit    by    certified 
statements? 

20.  What  advantage  accrues  to  partners  through 
an  audit  by  a  C.  P.  A.  ?    What  are  the  usual  disturb- 
ances of  a  partnership?    How  would  you  proceed  to 
determine  the  value  of  a  stock  destroyed  by  fire? 

21.  How  may  the  interests  of  stockholders  be  pro- 
tected? 

22.  In   the   case   of   public   service   corporations, 
what  is  the  usual  result  of  secrecy  in  connection  with 
earnings?  Do  certified  statements  extending  over  three 
or  four  years  facilitate  in  any  way  the  sale  of  a  busi- 
ness? 

CHAPTER  III. 

AUDITOR'S  QUALIFICATIONS. 

24.  How  extensive  should  be  an  auditor's  knowl- 
edge of  bookkeeping? 

25.  To  what  extent  should  he  study  text  books 
and  professional  papers? 


AUDITING  THEORY  AND  PRACTICE— Montgomery          9 

26.  What  are  the  relative  merits  of  reading  and 
meditation,  and  practice  and  observation? 

27.  What  special  qualifications  should  he  possess? 
29.     What  should  be  an  auditor's  education? 


CHAPTER  IV. 

DUTIES  OF  AN  AUDITOR. 

34.  What  are  the  duties  of  an  auditor? 

35.  What  is  said  of  amateur  auditors? 

36.  What  is  said  of  official  auditors? 

37.  WTiat  is  a  "staff "  auditor? 

38.  What  is  a  professional  auditor  and  what  is 
his  liability? 

40.  Outline  the  duties  of  an  auditor  in  connection 
with  the  audit  of  a  partnership. 

41.  Of  what  importance  is  the  partnership  agree- 
ment?    Why  should  each  of  the  following  be  men- 
tioned : 

(a)  Nature  of  business; 

(b)  Capital; 

(c)  Changes  in  capital; 

(d)  Interest  on  capital; 

(e)  Withdrawals; 

(f)  Undrawn  profits; 

(g)  Interest  on  loans  or  withdrawals; 
(h)  Distribution  of  profits  or  losses; 
(i)  Approval  of  accounts; 

(j)  Salaries  of  partners; 

(k)  Dissolution; 

(1)  Causes  for  dissolution; 

(m)  Settlement  after  dissolution; 

(n)  System  of  accounts; 

(o)  Disputes  about  accounts; 


10  GUIDE  TO   THE   STUDY   OF  AUDITING 

(p)     Firm  insurance; 

(q)     How  to  avoid  litigation? 

44.  In  your  estimation,  to  what  degree  should  an 
auditor  advise  his  clients?  Who  usually  appoints  the 
auditors  of  a  corporation? 

47.  How  may  an  auditor  prove  of  value  to  a  di 
rector  or  officer  in  connection  with  the  responsibility 
of  the  position  of  the  latter?    To  whom  should  he  re- 
port? 

48.  To  what  extent  may  an  auditor  criticize  an  of- 
ficer of  a  company? 

50.  Is  it  desirable  that  the  accountant  when  act- 
ing as  an  expert  witness  have  his  own  papers  and 
records  available? 

52.  May  an  auditor  disclose  any  information  un- 
favorable to  the  client?     Should  an  auditor  express 
his  opinions  before  a  court? 

53.  Mention  the  advantages  or  objections  to  audit- 
ing eleemosynary  corporations. 


CHAPTER  V. 

ETHICAL  DUTIES — LEGISLATION. 

58.     Along  what  lines  can  the  most  good  be  ac- 
complished through  the  Legislatures? 

60.  Is  it  desirable  that  full  reports  be  given  stock- 
holders? 

61.  What  should  a  balance  sheet  of  a  corporation 
contain? 

64.     Mention  the  principal  features  of  the  English 
Companies  Act. 


AUDITING  THEORY  AND  PRACTICE— Montgomery        11 

CHAPTER  VI. 

How  TO  BEGIN  AN  AUDIT. 

66.  Suggest  a  preliminary  program  for  an  audit. 
Why  is  it  desirable  to  fix  the  legal  responsibility  of 
the  client?    Outline  the  advantages  of  a  thorough  un- 
derstanding before  starting  an  audit. 

67.  Should  overtures  be  made  to  secure  the  co-op- 
eration of  the  client's  staff?    Should  the  auditor  en- 
deavor to  instruct  the  client's  staff,  and  if  so,  how? 

68.  Is  it  desirable  to  allow  it  to  appear  that  the 
auditor's   purpose   in  connection   with   a  particular 
audit  is  the  detection   of   fraud?     To  what  extent 
should  an  auditor  criticize  his  client's  staff  or  any 
member  of  it? 

70.     Which  is   preferable,   a  per  diem   rate  or  a 
stated  fee?    Why? 

72.  Under  what  circumstances  may  an  auditor  ac- 
cept work,  the  compensation  for  which  is  based  on  a 
contingency  ? 

73.  In  agreeing  to  make   an    audit,    should    any 
mention  be  made  as  to  the  place  where  the  audit  is 
to  be  conducted?    Why? 

74.  State  what  supplies  are  necessary  to  start  an 
audit. 

77.  What  should  be  done  with  the  working  papers? 

78.  Of  what  value  is  a  list  of  the  books  to  be  used 
in  an  audit? 

79.  Should  an  auditor  inquire  into  the  work  of 
his  predecessor? 

80.  What,  if  anything,  in  the  methods  of  conduct- 
ing the  accounts,  would  lead  you  to  reduce  the  scope  of 
your  audit?    What  is  a  detailed  audit?    Of  what  value 
is  an  audit  which  consists,  only,  of  a  verification  of 
cash  payments  and  the  trial  balance? 


12  GUIDE   TO  THE    STUDY  OF   AUDITING 

82.  How  would  the  existence  of  an  audit  staff  af- 
fect the  scope  of  your  audit? 

83.  How  should  cash  be  treated  under  a  system  of 
internal  check?    Should  the  cashier  be  allowed  access 
to  ledgers  or  statements  to  customers?    Why? 

84.  What  is  the  purpose  of,  and  how  should  vouch- 
ers be  used  under  a  system  of  internal  check?    Should 
a  copy  of  all  invoices  to  customers  be  retained  and 
rechecked?     Why?     Discuss  the  manner  of  treating 
customers'  accounts.    What  is  necessary  in  a  system 
of  internal  check  regarding  the  treatment  of : 

(a)     Inventories;    (b)    Collections;    (c)    Incoming 
mail;  (d)  Pay  rolls? 

85.  What  records  should  an  auditor  require  be- 
fore commencing  an  audit? 

CHAPTER  VII. 

BALANCE  SHEET  AUDIT — ASSETS. 

87.  State  the  general  principles  of  a  balance  sheet 
audit.     What  are  the  limitations  of  a  balance  sheet 
audit?    Is  it  proof  against  fraud?    Why? 

88.  Should  a  book  entry  covering  the  acquisition  of 
a  fixed  asset  be  verified  in  a  balance  sheet  audit?    Men- 
tion  the  synonyms  of  "Current  Assets."     Are  the 
changes  that  may  occur  in  the  value  of  items  in  the  ac- 
counts, between  the  date  of  the  closing  of  the  books 
and  the  date  of  the  performance  of  the  audit,  of  im- 
portance ?    Why  ? 

89.  Of  what  value  are  insurance  policies  in  deter- 
mining the  existence  of  liens  or  encumbrances?    Is  the 
proportion  of  current  assets  to  liabilities  and  capital 
of  importance?    Why? 

90.  What  may  a  capital  approximating  the  amount 
of  sales  indicate? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        13 

91.  When  should  the  cash  be  verified?    May  a  bank 
pass-book  be  accepted  as  conclusive  evidence?    Why? 
What  is  the  usual  procedure  in  making  certain  of  bank 
balances? 

92.  To  what  extent  is  the  average  cash  balance  of 
interest  to  the  auditor?    Would  you  consider  it  neces- 
sary to  inquire  extensively  into  a  petty  cash  balance 
of  say  |400.00  or  |500.00?    Why?    Under  what  con- 
ditions is  it  desirable  to  make  a  second  count  of  the 
cash  on  hand? 

93.  Should  an  auditor  feel  called  upon  to  report  on 
a  cash  memorandum  of  an  amount  less  than  a  week's 
salary  signed  by  the  cashier? 

94.  Explain  why  it  is  desirable  to  verify  all  cash 
balances    simultaneously?      How    should    consigned 
goods  be  treated? 

95.  Under  what  conditions  would  a  compilation 
of  percentages  covering  gross  and  net  figures  of  vari- 
ous lines  of  business  be  of  value  to  a  professional  audi- 
tor?   What  inference  would  you  draw  from  an  account 
which  showed  a  partial  payment  on  an  old  invoice  and 
complete  payments  on  invoices  of  later  date?     How 
would  you  treat  accounts  receivable  in  your  report? 
What  constitutes  an  "account  stated"?    If  any  entries 
would  appear  in  the  books  to  record  the  assignment 
of  accounts  to  a  banker,  state  them. 

96.  How  would  you  proceed  to  value  overdue  trade 
accounts?     Do  you  believe  that  a  reserve  for  cash 
discount  should  be  placed  on  the  books?     Give  rea- 
sons. 

97.  What  is  said  of  rents  receivable? 
(See  "Accounting  Principles.") 

98.  What  may  properly  be  included  under  the  cap- 
tion "accounts  receivable"?    Explain  how  you  would 
deal  with  advances  on  contracts  of  purchase. 


14  GUIDE  TO   THE   STUDY   OF  AUDITING 

99.  Outline  the  treatment  of  "Deposit  to  secure  a 
Lease." 

100.  How  would  you  verify  the  accounts  receiv- 
able? 

CHAPTER  VIII. 

BALANCE  SHEET  AUDIT — CURRENT  ASSETS 
(Continued). 

101.  How  should  notes  receivable  under  discount 
be  shown  in  the  balance  sheet?     Is  anything  gained 
by  transferring  overdue  notes  to  the  account  of  the 
customer?     (See  "Accounting  Principles.") 

102.  Upon  which  would  suit  be  made,  the  account 
or  the  overdue  note?    How  would  the  matter  of  suit 
affect  the  desirability  of  transferring  the  note?    Un- 
der what  conditions  may  overdue  notes  be  considered 
as  of  equal  value  to  those  not  due? 

103.  Outline  the  treatment  of  notes  received  on 
stock  subscriptions.    What  entries  are  usually  made 
where  goods  are  sold  and  the  contracts  are  payable 
in  installments?     How  should  installment  sales  be 
treated  for  balance  sheet  purposes? 

104.  What  may  properly  be  included  under  the 
caption    raw    material?"      Do    you    agree    witli    the 
author  in  the  assertion  that  the  inventory  value  of 
goods  should  be  changed  from  time  to  time  under  cer- 
tain conditions?    Is  a  banker  justified  in  presuming 
that  the  values  mentioned  in  a  balance  sheet  represent 
actual  current  worth?    Is  it  desirable  that  a  profit  be 
anticipated  on  account  of  a  rising  market?     Why? 
What  procedure  is  desirable  in  case  a  portion  of  the 
stock    has    deteriorated?      (See    "Accounting    Prin- 
ciples.") 

105.  Should  special  consideration  be  given  large 
items  which  appear  in  the  inventory?    Why? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        15 

106.  Discuss  the  question  of  stock  taking  and  the 
liability  and  duties  of  auditors  dn  that  connection. 

107.  Why  is  it  desirable  to  secure  the  original  pen- 
cil copy  of  the  inventory?     To  what  extent  is  it  de- 
sirable to  test  the  accuracy  of  any  of  the  items  men- 
tioned in  an  inventory?     Under  what  conditions  is 
it  considered  proper  to  accept  as  authentic  an  inven- 
tory taken  from  the  stores-record? 

108.  Why  should  the  possibility  of  post-dated  in- 
voices interest  the  auditor?    To  what  extent  need  an 
inquiry  be  made  into  the  purchase  of  the  articles  in- 
cluded in  the  inventory?     May  duty  and  freight  be 
properly  included  in  the  cost  of  goods? 

109.  What  is  the  "gross  profit  test"  and  under 
what  conditions  is  its  use  possible?    What  informa- 
tion would  an  auditor  possibly  secure  by  a  comparison 
of  the  unit  inventory  price  with  the  unit  selling  price 
of  a  particular  product? 

110.  How  would  you  proceed  to  value  goods  in  pro- 
cess?    (See  "Accounting  Principles.")      Is  the  ten- 
dency to  overstate  inventories  peculiar  to  any  par- 
ticular class  of  business? 

111.  May    administrative    and    selling    expenses 
properly  be  included  in  the  inventory  as  a  portion  of 
the  cost  of  goods  manufactured  on  contract?     How 
should  finished  goods  be  valued?    What  are  the  ob- 
jections to  the  plan  of  inventorying  finished  goods  at 
selling  price  less  a  percentage  to  represent  the  profit 
on  the  sale  or,  as  is  sometimes  the  case,  less  an  amount 
to  represent  the  expense  of  delivery? 

112.  May  rent  and  interest  be  included  in  the  cost 
of  goods  manufactured,  when  inventorying?    Explain 
the  manner  of  dealing  with  goods,  the  selling  price  of 
which  is  below  the  actual  cost.     Define  turnover  and 


16  GUIDE  TO   THE   STUDY  OF  AUDITING 

explain  its  importance  in  an  audit.  (See  "Accounting 
Principles.") 

113.  Explain  the  manner  of  treating  supplies  and 
also  the  reason  why  they  require  a  treatment  different 
from  material  in  inventories.     How  would  you  show 
an  account  represeting  the  controlling  interest  in  an- 
other company  in  the  balance  sheet  of  the  holding 
company,  viz.,  as  a  current  or  a  fixed  asset? 

114.  Would  the  treatment  of  stock  held  as  an  in- 
vestment be  different  from  that  of  stock  held  to  con- 
trol a  subsidiary  organization?     How  should  securi- 
ties be  valued?    Need  any  consideration  be  given  the 
unmatured  coupons?     Is  an  auditor  justified  in  at- 
tempting to  value  securities  and  similar  investments? 
What  value  attaches  to  a  record  of  serial  numbers  of 
securities,  in  connection  with  the  detection  of  fraud? 
What  precaution  should  be  taken  to  assure  the  actual 
existence  and  verification  of  all  bonds? 

115.  Is  it  desirable  to  apply  a  different  rule  in 
the  valuation  of  cash  or  quick  investments  than  would 
be  proper  in  the  case  of  more  permanent  ones?    Why? 
How  would  the  auditor  proceed  to  test  the  availability 
of  this  class  of  securities? 

116.  What  consideration  do  stamps  require? 

CHAPTER  IX. 
BALANCE  SHEET  AUDIT — FIXED  ASSETS. 

117.  Define  "fixed  assets."     How  should  they  be 
valued? 

119.  Outline  the  auditor's  duty  and  responsibility 
in  connection  with  their  valuation.  Under  what  con- 
dition may  their  "scrap  value"  be  used?  Does  real 
estate  require  any  particular  attention,  and  if  so, 
what? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        17 

120.  Should  the  author  attempt  a  personal  exam- 
ination of  the  title  to  the  property?    Should  any  at- 
tempt be  made  to  sub-divide  the  real  estate  holdings  of 
a  company?    Would  the  fact  that  the  concern  under 
audit  is  a  real  estate  concern  influence  your  treatment 
of  this  item?    State  the  treatment  of  land  in  the  ac- 
counts.   Need  it  be  reduced  on  the  books  if  an  unfa- 
vorable fluctuation  has  occurred?    Why? 

121.  Should  a  distinction  be  made  between  im- 
proved or  unimproved  land?     Give  reasons.     Is  the 
treatment  of  "carrying  charges"  properly  dealt  with  in 
this  chapter?    In  answering,  give  consideration  to  the 
rule  that  all  expenses  incurred  during  the  period  of 
incipiency  of  an  undertaking  may  properly  be  capi- 
talized.   Need  an  auditor  call  attention  to  an  increase 
in  the  book  value  of  land  made  in  giving  effect  to  a 
favorable  fluctuation?    Why? 

122.  For  what  reason  is  it  undesirable  even  to  as- 
sume an  increase  in  the  value  of  land  which  constitutes 
a  portion  of  the  plant  of  an  undertaking,  even  though 
surrounding   property   is   undoubtedly   worth   much 
more?      Outline  the  manner  of  treating  the  account 
representing  buildings,  in  the  books?     Does  the  fact 
that  the  plant  might    be    upon    leased    ground    re- 
quire consideration?    If  so,  how  may  this  feature  af- 
fect the  treatment  of  the  accounts? 

123.  If  the  lease  has  increased  in  value  to  the  ex- 
tent that  it  is  worth  much  more  than  the  building 
situated  upon  the  land,  need  depreciation  be  written 
off? 

124.  Would  the  fact  that  the  purchase  price  of  the 
lease  is  in  excess  of  its  real  value  and  that  the  annual 
charge  to  revenue  on  account  of  its  amortization  is  in 
excess  of  the  amount  that  like  premises  can  be  rented 
for,  necessitate  the  writing  down  of  the  lease  account 


18  GUIDE   TO  THE   STUDY  OP  AUDITING 

to  its  actual  value?  How  should  machinery  and  equip- 
ment be  valued?  Define  obsolescence.  Of  what  value 
is  a  plant  ledger  to  the  auditor? 

125.  Explain  the  theory  that  the  usual  charges  for 
depreciation  are  excessive.      How  would  you  treat  dis- 
carded machinery? 

126.  How  should  small  tools  be  treated?    Discuss 
the  treatment  of  fixtures,  giving  consideration  to  those 
on  leased  property  as  well  as  their  physical  condition. 
Discuss  the  treatment  of  packages  returnable,  also  of 
deposits  that  may  have  been  made  thereon. 

127.  Upon  what  basis  should  depreciation  be  writ- 
ten off  horses  or  how  should  the  account  be  treated? 
What  is  a  satisfactory  rate  of  depreciation  on  auto- 
mobiles? Discuss  the  treatment  of  patterns,  drawings, 
etc.,  in  the  accounts. 

128.  How  should  plates  of  a  book  be  valued? 

129.  Discuss  the  valuation  of  patents.    What  con- 
ditions tend  to  decrease  the  value  of  patents  other  than 
expiration  of  life?     (See  "Accounting  Principles.") 

130.  Wherein  does  the  treatment  of  copyrights  dif- 
fer from  that  of  patents? 

CHAPTER  X. 

BALANCE  SHEET  AUDIT — FIXED  ASSETS  (Continued). 

131.  Is  depreciation  applicable  to  goodwill?    Dis- 
cuss the  advisability  of  decreasing  or  increasing  the 
value  of  goodwill.     What  is  the  effect  of  writing  off 
goodwill?      (See  "Accounting  Principles.") 

132.  Mention  a  few  of  the  elements  of  business 
which  constitute  goodwill. 

135.  Endeavor  to  explain  just  what  goodwill  repre- 
sents. Is  the  term  "fund"  ever  properly  used  on  the 
credit  side  of  a  balance  sheet?  What  is  the  usual  pur- 


AUDITING  THEORY  AND  PRACTICE — Montgomery        19 

pose  of  a   sinking   fund?      (See   "Accounting   Prin- 
ciples." ) 

136.  To  what  extent  should  an  auditor  verify  the 
existence  of  sinking  fund    assets?      Mention   a   few 
items  that  may  properly  be  included  under  the  cap- 
tion "Fund  and  other  Permanent  Investments."  State 
the  difference  in  the  treatment  of  permanent  and  tem- 
porary investments  in  the  inventory.     Explain  fully 
the  treatment  of  bond  investments  in  the  accounts. 

137.  Why  is  it  desirable  to  mention,  also,  the  mar- 
ket values  of  bonds,  where  the  plan  of  amortization  is 
used  in  determining  their  value  for  balance  sheet  pur- 
poses? 

138.  To  what  extent  is  the  auditor  interested  in  the 
terms  of  the  various  mortgages  or  trust  deeds  that  may 
have  been  issued  by  the  company  under  audit?    In  the 
case  of  the  sale  of  obsolete  property  which  is  included 
in  the  security  mentioned  in  a  mortgage,  what  disposi- 
tion should  be  made  with  the  cash  received  for  it? 
What  constitutes  treasury  stock  and  how  should  it 
appear  in  the  balance  sheet  under  various  conditions? 

139.  Explain  the  usual  method  of  entering  capital 
stock  of  a  company  on  the  books,  presuming  that  a  por- 
tion has  been  subscribed  and  issued  and  that  some  of 
it  still  remains  unissued.  Is  timber  a  fixed  or  a  current 
asset?    In  dealing  with  the  valuation  of  a  mine  or  tim- 
ber do  the  rules  of  depreciation  apply  or  is  it  a  case 
of  inventory  value?      (See    "Wasting   Assets,"    "Ac- 
counting Principles.")    May  dividends  be  paid  out  of 
capital  in  the  case  of  a  company  operating  a  wasting 
asset?    WThat  bearing  do  the  by-laws  of  a  company 
have  on  the  validity  of  a  dividend  where  the  capital 
of  such  a  company  is  being  distributed? 

140.  State  the  proper  procedure  of  an  auditor  veri- 
fying the  mines  account.    How  is  the  value  of  timber 


20  GUIDE   TO  THE    STUDY   OP  AUDITING 

ascertained?  What  are  contingent  assets?  If  the  cor- 
poration audited  is  a  double  liability  corporation, 
should  mention  be  made  of  the  fact? 

141.  What  consideration  should  be  given  to  calls  in 
arrears?  Need  any  consideration  be  given  the  possibil- 
ity that  the  directors  may  be  liable?  Why?  Define 
"Secret  Reserves"  and  explain  how  they  are  created. 
(See  "Accounting  Principles.") 

143.  What  action  should  an  auditor  take  where 
an  inventory  is  deliberately  reduced  to  an  improper 
sum? 

144.  How  does   the   deliberate   writing  down   of 
asset  values  affect  the  minority  stockholder?     How 
should  the  profit  and  loss  account  be  prepared  where 
it  is  desired  that  the  stockholders  will  not  be  mislead 
by  excessive  charges  to  it,  made  with  a  view  of  creat- 
ing a  secret  reserve?    What  appears  to  be  the  proper 
treatment  of  bank  fixtures  and  buildings  in  the  ac- 
counts? 

146.  Is  it  ever  proper  to  omit  an  asset  from  the 
books?  Why? 

CHAPTER  XI. 

BALANCE  SHEET  AUDIT — LIABILITIES. 

148.  What  is  the  most  important  duty  of  an  au- 
ditor in  respect  to  the  liabilities  of  the  concern  under 
audit?    What  consideration  should  be  given  contracts 
covering  the  purchase  of  goods? 

149.  Outline  the  auditor's  duty  in  regard  to  ac- 
counts payable. 

153.  Discuss  the  treatment  of  cash  discounts.  How 
should  sales  of  consigned  goods  be  treated? 

154.  How  should  notes  payable  be  divided? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        21 

155.  What  particular  points  require  attention  in 
connection  with  the  verification  of  notes  payable? 
Discuss  the  treatment  of  mortgages  in  an  audit. 

157.  Does  the  interest  that  accrues  on  a  bond  be- 
come an  additional  lien  on  the  security?    Does  an  in- 
creased period  of  life  of  a  bond  issue  necessarily  de- 
crease the  value?    Why?    Do  judgments  require  spe- 
cial consideration? 

158.  Is    interest   payable   a   current   or   a   fixed 
liability? 

159.  Is  a  reserve  for  taxes  essential?    Why?    What 
is  the  procedure  in  determining  the  liability  for  ac- 
crued wages? 

160.  Discuss  the  treatment  of  an  existing  liability 
for  freight.    What  procedure  is  necessary  in  connec- 
tion with  amounts  due  salesmen?    Is  it  necessary  to 
set  up  a  reserve  to  cover  audit  expense? 

161.  What   consideration   do   damage   claims   re- 
quire?    Outline  the  usual  treatment  of  car  tickets, 
coupons,  etc. 

162.  Explain    the    usual    treatment    of    deposits 
made  by  consumers  to  a  gas  company  to  protect  the 
company.     Discuss  the  treatment  of  '"Deposits  of 
Employees." 

163.  What  is  the  proper  treatment  of  dividends  in 
the  accounts? 


CHAPTER  XII. 

BALANCE  SHEET  AUDIT — CONTINGENT  LIABILITIES 
AND  CAPITAL. 

165.  What  is  a  contingent  liability? 

166.  Should  a  reserve  for  bad  debts  include  an 
amount  to  protect  the  loss  through  bad  notes?     (See 
"Accounting  Principles.")     Outline  the  treatment  of 


22  GUIDE   TO   THE   STUDY   OF  AUDITING 

notes  in  the  accounts,  giving  consideration  to  their 
acceptance,  hypothecation  and  payment.  Discuss 
"indorsements." 

167.  In  the  case  of  an   accommodation   indorse- 
ment, what  entries,  if  any,  would  you  find  on  the 
books  and  what  would  be  their  comparative  value? 

168.  How  do  investments  in  other  companies  often 
influence  the  financial  standing  of  a  concern? 

169.  Under  what  conditions,  if  any,  is  it  desirable 
to  mention  "Guarantees"  in  the  accounts? 

170.  Do  unfilled  contracts  affect  the  financial  con- 
dition of  a  concern,  presuming  that  goods  are  to  be 
received  of  an  amount  equal  to  the  liability  that  is 
to  be  placed  on  the  books  at  the  time  the  goods  arrive? 

171.  Of  what   value  is   the   minute   book   to -an 
auditor?     Is  an  auditor  justified  dn  mentioning  his 
inability  to  inspect  the  minute  book,  in  his  report? 
What  information  may  be  disclosed  by  an  inspection 
of  the  minute  book? 

172.  What  are  reserves? 

174.  For  the  purpose  of  comparison,  cite  the  views 
of  other  authors  in  connection  with  reserve  accounts 
and  reserve  funds  and  explain  where  Mr.  Montgomery 
differs.      (See  "Accounting  Principles.") 

175.  Should  special  attention  be  given  the  presen- 
tation of  the  proprietary  interest  in  the  concern  when 
preparing  a  balance  sheet?     Why? 

176.  Mention  the  duties  of  an  auditor  in  regard 
to  the  capital  stock  and  also  the  features  that  will 
require  particular  attention. 

177.  What  account  should   be  credited   with  pre- 
miums received  on  an  issue  of  stock  and  what  should 
ultimately  be  done  with  the  account?     (See  "Accoun- 
ing  Principles.")     How  should  a  reserve  for  deprecia- 
tion appear  in  the  books?    Where  sinking  funds  are 


AUDITING  THEORY  AND  PRACTICE— Montgomery        23 

operated  in  connection  with  obligations  on  mines,  etc., 
and  where  they  agree  in  amount  with  the  depletion  of 
the  property,  need  provision  be  made  for  depreciation 
or  depletion?  (See  "Income  on  Reserve  Investments" 
— "Accounting  Principles." ) 

178.  Explain  the  use  and  purpose  of  a  reserve  for 
exhaustion   account.     Under   a   condition    in   which 
sinking  fund  requirements  provide  for  the   setting 
aside  of  a  sum  greatly  in  excess  of  the  proper  charge 
for  depletion,  how  would  you  provide  for  the  proper 
display  of  information  as  to  earnings  in  the  profit 
and  loss  account?     Of  what  should  a  reserve  for 
working  capital  consist  and  what  is  its  purpose? 

179.  How   should  dividends   on   cumulative  pre- 
ferred stock  which  are  in  arrears  appear  in  the  bal- 
ance sheet?     What  book   entry,   if  any,   should  be 
made?    ( See  "Accounting  Principles." )  Where  should 
"Surplus"  appear  in  the  balance  sheet? 

180.  Should  the  use  of  the  term   "Surplus"   be 
restricted  to  represent  sums  properly  available  for 
dividends? 

CHAPTER  XIII. 

PROFIT  AND  Loss  ACCOUNT. 
182.     Define  "Net  Profit." 

186.  What  items  should  be  deducted,  or  excluded, 
from   gross  earnings?     Under  what  condition   may 
rebates  and  allowances  be  included  in  the  sales  ac- 
count  and    the   net   amount    only    shown?      Where 
should  a  reserve  for  bad  debts  be  shown  in  a  profit 
and  loss  account?     Where  should    the    account    ap- 
pear in  the  balance  sheet? 

187.  May  a  profit  be  assumed  on  work  in  progress 
and  if  so,  under  what  conditions? 

189.     How  should  departmental  profits  be  treated? 


24  GUIDE   TO  THE   STUDY  OP  AUDITING 

190.  How  should  the  profits  of  a  subsidiary  com- 
pany on  inter-company  transactions  be  treated  in 
the  reports  of  a  holding  company? 

192.  Discuss   the  treatment  of  sales   for   future 
delivery  and  the  advisability  of,   or  objections  to, 
assuming  a  profit  in  advance  of  actual  delivery. 

193.  May   a  profit  be  assumed   on  underwriting 
transactions  in  advance  of  the  closing  of  the  syn- 
dicate?    Is  the  profit  on  the  sale  of  a  fixed  asset 
properly  available  for  dividends?     Outline  a  desir- 
able manner  of  treating  such  profits  in  the  books. 
May  an  appreciation  in  the  value  of  a  fixed  asset  be 
credited  to  surplus  account  and  later  declared  as  a 
dividend? 

194.  What  are  the  objections  to  placing  the  ap- 
praised  value    of   a    plant  on  the  books?     What  is 
the  effect  of  such  an  act  on  the  future  net  profits 
of  the  concern,  presuming  that  at  the  time  of  the 
appraisal  the  asset  accounts  were  considerably  in- 
creased on  the  books? 

CHAPTER  XIV. 

PROFIT  AND  Loss  ACCOUNT  (Continued). 
197.     What  is  said  about  depreciation  and  obso- 
lescence? 

199.  Is  obsolescence  a  charge  against  operations 
or  against  net  profits? 

200.  Does  the  fact  that  it  is  difficult  to  deter- 
mine the  amount  of  the  reserve  for  obsolescence  elim- 
inate the  necessity  of  the  reserve  or  the  placing  of  the 
charge  in  the  profit  and  loss  account?     How  should 
"Accrued  Expenses"  overlooked  in  a  particular  year 
be  treated  in  the  profit  and  loss  account  of  the  suc- 
ceeding year?       (See  "Profit  and  Loss  Adjustments" 
— "Accounting  Principles." ) 


AUDITING  THEORY  AND  PRACTICE— Montgomery        25 

201.  Are    cash     discounts     an    expense    of    the 
business  or  is  the  account  a  deduction  from  sales? 
(See  "Accounting  Principles.")     Do  trade  discounts 
properly  appear  in  the  books? 

202.  The  amount  of  net   profit   having   been   de- 
termined upon,  what  is  the  proper  procedure  in  dis- 
posing  of   the   amount?    What   is    said   about   re- 
taining in  the  company  the  profits  which  are  avail- 
able for  dividends? 

203.  Of  what  value  is  an  accurate  determination 
of  what  is  chargeable  to  capital  and  what  is  charge- 
able to  revenue?     Discuss  the  declaration  of  divi- 
dends in  connection  with  the  following  businesses, 
each  operating  a  wasting  asset: 

(a)  Mining  company; 

(b)  Steel  company  operating  a  subsidiary 

mining  company; 

(c)  Life  tenant  of  an  estate. 

206.  Discuss  the  apportionment  of  interest  and 
dividends  in  the  case  of  a  decedent's  estate.    What  is 
said  in  reference  to  extraordinary  dividends? 

CHAPTER  XV. 

CERTIFICATES  AND  REPORTS. 

207.  What  is  said  of  the  object  of  the  audit? 

208.  What  does  the  banker  expect  of  an  auditor's 
report?     Is  it  desirable  to  submit  a  supplementary 
report  to  the  bankers? 

209.  Outline   the   scope   of   the   report.      Should 
the  auditor  outline  the  work  done  in  the  audit  when 
preparing  a  report? 

210.  How  does  the  purpose  of  an  audit  affect  the 
report?    What  should  the  certificate  of  audit  include? 


26  GUIDE   TO  THE   STUDY   OF   AUDITING 

211.  State   the   procedure   where,   owing   to    the 
period  that  has  elapsed  or  for  other  reasons,  it  is 
impossible  to  certify  that  the  balance  sheet  agrees 
with  the  books. 

212.  Explain  the  difference  between  the  American 
and  English  balance  sheet  forms  and  give  the  rea- 
sons advanced  for  their  use. 

213.  Explain  what  is  meant  by  the  account  form 
of  balance  sheet. 

214.  What  information  should  an  ideal  balance 
sheet  set  forth?     In  what  order  should  the  assets 
appear?    In  what  order  should  the  liabilities  appear? 
How  should  deferred  charges  to  operations  appear 
in  a  balance  sheet?    Where  should  the  item  "Good- 
will" be  placed?    What  class  of  reserves  may  properly 
be  included  under  the  heading  "Reserves"  if  the  item 
is  placed  as  shown  in  the  form  on  page  214?     (See 
"Accounting  Principles.") 

215.  What  are  the  objections  to  the  form   most 
generally  used  by  large  industrial  corporations?    Dis- 
cuss the  advantages   or   disadvantages    that   accrue 
through  placing  the  capital  stock  first  and  the  sur- 
plus last  in  a  balance  sheet.     What  advantages  are 
possessed  by  the  account  form  that  are  not  possessed 
by  the  statement  form  of  balance  sheet? 

216.  What   is   to   be   gained   from   the   study    of 
how  to  place  the  various  groups  of  items? 

217.  Compare  the  Standard  Form  of  Borrowers 
Statement  with  the  form  on  page  214  and  point  out 
the  differences,  explaining  the  reasons  therefor. 

218.  Compare  the  forms   on  pages   217   and  220 
and  point  out  their  relative  advantages. 

222.  Criticize  the  arrangement  of  the  assets  in 
the  form  on  page  222.  Explain,  if  possible,  the  ad- 
vantages of  separating  the  liabilities  as  shown  in 


AUDITING  THEORY  AND  PRACTICE— Montgomery        27 

this  form.  Do  you  believe  that  for  most  concerns  an 
accurate  distribution  of  liabilities  could  be  made  un- 
der the  various  headings  mentioned?  What  could  be 
the  object  of  the  question,  "Is  the  surplus  at  the  risk 
of  the  business"? 

223.  State  the  purpose  of  the  last  question  on 
page  223.  Discuss  the  relative  merits  of  the  two  forms 
shown  on  pages  222  and  223. 


CHAPTER   XVI. 
CERTIFICATES  AND  REPORTS. 

226.  Mention    a   few   of  the  advantages   of   this 
form  for  the  purpose  it  is  intended. 

227.  Discuss    liens    and    hypothecations   in    con- 
nection with  an  audit. 

228.  To   what   extent  is  an   auditor   responsible 
where  he  has  not  discovered  evidence  of  a  lien? 

229.  Will  the  item  "Net  Profits  from  Operations" 
be  truly  stated  if  the  item  "Other  Earnings"  is  added 
to  "Gross  Profits"?    Do  you  believe  the  item  "Extra- 
ordinary Profits"  should  be  stated  separately  from 
"Surplus  for  the  Year" ;  or  should  the  surplus  contain 
the  extraordinary  items;  or  would  it  be  preferable  to 
modify  the  item  "Surplus  for  the  Year"  in  some  way? 
Give  reasons. 

230.  In  addition  to  the  statement  of  profits  or 
losses,  what  information  may  properly  be  included  in 
a  profit  and  loss  account?     To  what  extent  may  an 
auditor  use  information  secured  from  the  accounts  of 
his  clients? 

231.  What  advantages  attach  to  the  use  of  charts? 
How  may  the  results  of  comparative  years  be  shown? 


28  GUIDE   TO  THE   STUDY  OF  AUDITING 

232.  How  may  the  same  chart  be  used  to  contain 
information  of  various  classes,  some  of  which  are 
computed  on  a  different  unit  than  others? 

233.  Prepare    a    chart    based    on    the    following 
figures : 

Sales      Cost&Exp.  Net  Profit 

January    18000  17200  800 

February    19500  18400  1100 

March  22000  20250  1750 

April  21500  19900  1600 

May  20000  18750  1250 

June    16000  15750  250 

July    15000  15000  

August   15300  15200  100 

September    15600  15450  150 

October  17700  17000  700 

November  18600  17700  900 

December  21000  19500  1500 

234.  Explain  the  advantage  of  a  "sales  and  pur- 
chase chart."    Draw  a  chart  showing  sales  and  pur- 
chases based  upon  the  following  information : 

Sales  Purchases 

January    170,000  160,000 

February    180,000  162,500 

March  180,000  165,000 

April  187,000  172,500 

May  196,000  174,000 

June 193,000  176,000 

July  192,000  180,000 

August   190,000  182,000 

September    187,000  185,000 

October  186,000  185,000 

November  187,500  195,000 

December 192,500  200,000 


AUDITING  THEORY  AND  PRACTICE— Montgomery        29 

(a)  Draw  the  perpendicular  lines  %-inch  apart 
and  the  horizontal  lines  %-inch  apart  and  let  the 
lower  line  represent  the  unit  150,000. 

(b)  Prepare    a    chart    containing    the    same    in- 
formation as  before  but  have  all  the  parallel  lines 
%-inch  apart  and  allow  the  lower  line  to  represent 
zero.       In  the  two  charts   just   prepared   point   out 
by  a  comparison  of  relative  distances  the  defects  in 
the  information  conveyed.     ( See  Dicksee's  "Advanced 
Accounting." ) 

236.     How  may  a  study  of  comparative  statistics 
act  as  a  preventive  of  fraud? 

238.  What  are  the  advantages  of  including  a  list 
of  accounts  receivable  in  a  report?    Of  what  value  is 
an  investigation  of  outstanding  unpaid  bank  checks? 

239.  How  far  may  an  auditor  restrict  the  use  of 
his  report  or  portions  thereof? 


CHAPTER  XVII. 
THE  DETAILED  AUDIT — GENERAL  PRINCIPLES. 

241.  Distinguish  between  a  completed  and  a  con- 
tinuous audit.     Mention  a  few  of  the  advantages  of 
a  continuous  audit. 

242.  How    do    you    account    for    the    preference 
given  the  completed  audit? 

243.  State    the    purpose   and    limitations    of    an 
audit  note  book. 

247.  State  the  general    principles  which    govern 
procedure    in    the    detailed    audit    of    income    and 
expenses. 

248.  Is  an  auditor  justified  in  proving  all  foot- 
ings and  postings?     If  fraud  exists  with  respect  to 
purchase,  where  is  it  likely  to  be  found? 


30  GUIDE   TO  THE   STUDY   OF  AUDITING 

249.  Outline  the  procedure  in  testing  the  pur- 
chase ledger. 

251.  How  would  you  proceed  to  detect  fraud  in 
the  accounts  receivable? 

252.  What  attention,  if  any,  should  be  given  the 
reconciliation  of  bank  balances? 

254.  Outline  a  desirable  plan  for  handling  cash 
receipts.  How  may  cash  payments  be  fraudulently 
manipulated? 

256.  To  what  extent  should  an  auditor  verify  the 
accounts  payable. 

257.  Mention   a  few   of  the  advantages   derived 
from  the  use  of  a  considerable  number  of  books  wdth 
appropriate  names. 


CHAPTER  XVIII. 

THE  DETAILED  AUDIT  (Continued) — VERIFICATION 
OF  INCOME. 

259.  What  steps  should  an  auditor  take  in  verify- 
ing sales?    Mention  a  few  of  the  advantages  of  inspect- 
ing   memorandum    books    in    connection    with    the 
detection  of  fraud. 

260.  What  procedure  should  an  auditor  take  to 
detect  fraud  in  the  records  of  a  lumber   company 
which  ships  many  cars  of  lumber  to  all  parts  of  the 
United  States,  much  of  which  is  billed  to  jobbers 
rather  than  to  the  consignee?     Give  consideration 
to  the  possibility  of  the  yard  foreman  working  in 
collusion  with  a  jobbing  concern,  located  in  a  dif- 
ferent city,  of  which  he  is  the  principal  stockholder. 
Of  what  value  is  a  balance  sheet  in  tracing  fraud? 

261.  How  should  cash  discounts  be  treated  in  the 
cash  books?     (See  "Accounting  Principles.") 


AUDITING  THEORY  AND  PRACTICE — Montgomery        31 

262.  Explain  the  operation  of  the  lapping  system 
of  covering  cash  defalcations  and  give  the  procedure 
of  an  auditor  in  its  detection. 

264.  Explain  the  manner  of  verifying  the  accounts 
receivable. 

265.  What  is  the  proper  method  of  auditing  in- 
vestments? 

266.  Outline  a  desirable  plan  of  treating  invest- 
ments in  the  books. 

267.  What  consideration  does  interest  receivable 
require?    What  is  said  about  trade  discounts? 

268.  How  should  real  estate  holdings  be  treated 
in  the  accounts?  What  consideration  does  rents  re- 
ceivable require  on  the  part  of  the  auditor? 

269.  To   what  extent  is  an   auditor  justified  in 
making  an  inquiry  into  the  possible  realization  from 
accounts    previously    charged    to    profit    and    loss? 
How  should  consigned  goods  be  treated  in  the  books 
and  at  the  time   of   balancing?      (See    "Accounting 
Principles." ) 

270.  What   is   the   auditor's   duty    in    regard   to 
goods  received  for  sale? 

271.  Why  do  the  insurance  policies  require  at- 
tention ? 

272.  Is  it  permissible  to  include  any  portion  of 
the  profit  anticipated  on  a  sale,  the  goods  for  which 
are  still  in  process  of  manufacture?     What  portion 
of  the  expenses  attached  or  traceable  to  sales  not  de- 
livered, may  be  treated  as  deferred  charges  to  opera- 
tion? 

273.  Outline  the  procedure  in  verifying  the  rec- 
ords of  sales  of  lots  by  a  real  estate  company,  which 
is  selling  some  particular  addition. 


32  GUIDE   TO   THE   STUDY  OP  AUDITING 

CHAPTER  XIX. 

THE  DETAILED  AUDIT  (Continued) — PURCHASES 
AND  EXPENSES. 

274.  Of  what  value  are  vouchers  to  the  auditor? 

275.  Of  what  value  is  a  paid  check  as  evidence  of 
the  propriety  of  a  payment? 

276.  What   is   the  auditor's  duty   in   regard   to 
purchase  invoices? 

278.  Should   the    auditor    notice    the  names  to 
whom  the  purchases  are  charged?    As  an  example, 
assume  the  case  of  a  limited  liability  company  that 
is  in  financial  difficulties  to   an   extent  that  some 
of  the  creditors  are  billing  to  the  directors  of  the 
company  instead  of  to  the  company  itself.     Do  the 
dates  of  invoices  require  consideration?  Why?    What 
attention  should  be  given  missing  vouchers? 

279.  Outline    fully    a   proper   system    of   paying 
small  cash  items  and  explain  the  manner  in  which 
they  should  be  audited. 

281.  What  treatment  should  be  given  organiza- 
tion expenditures    and    expenditures    of     one  year 
which  are  presumed  to  have  been  made  with  a  view 
of  increasing  the  following  year's  profit?     (See  "Ac- 
counting Principles." ) 

282.  Is  the  expense  of  establishing  a  branch  of- 
fice a  proper  charge  against  operations? 

283.  How  should  extraordinary  expenditures  be 
treated? 

284.  Which  is  preferable  and  more  liable  to  be 
placed   on   the   books   without   opposition;   a   direct 
charge  or  a  reserve  for  repairs  and  renewals? 

285.  State  the  proper  treatment  of  returns  and 
allowances    and    the    auditor's    duty    in    connection 
therewith. 


AUDITING  THEORY  AND  PRACTICE— Montgomery        33 

286.  Discuss  the  treatment  of  "Empties." 

287.  What  attention  should  an  auditor  give  wages 
and  salaries  and  what  methods  of  handling  should 
he  recommend? 

288.  How    should    accounts    with    salesmen    be 
treated?    In  answering  this  question  give  considera- 
tion to  commission,  travelling  expense,  mileage,  ad- 
vances, and  cash.    How  would  you  proceed  to  prove 
the  accuracy  of  the  payments  made  in  settlement  of 
wages? 

290.  Do  the  amounts  paid  for  duty  require  any 
special  attention  on  the  part  of  an  auditor?     If  so, 
what? 

291.  Discuss  the  treatment  of  insurance. 

292.  Do   paid   freight   bills   require   any   special 
attention?  What  attention  should  be  given  the  postage 
account? 

294.     How  should  returned  purchases  be  treated? 


CHAPTER  XX. 

THE  DETAILED  AUDIT  (Continued) — THE  TRIAL 
BALANCE. 

296.  Is  it  the  auditor's  duty  to  locate  errors  in  a 
trial  balance? 

297.  What  is  said  about  outstanding  accounts? 
What  consideration  should  the  auditor  give  old  bal- 
ances appearing  in  a  current    account   with    a   cus- 
tomer?   Outline  the  most  desirable  method  of  treat- 
ing overdue  accounts  receivable. 

299.  What  consideration  should  be  given  notes 
receivable?  Which  is  preferable,  charging  a  protested 
note  to  the  personal  account  of  the  debtor  with  the 
protest  fees  included,  or  charging  the  bills  receivable 


34  GUIDE   TO  THE   STUDY  OF   AUDITING 

account  with  the  protest  fees  and  keeping  both  in 
that  account?  In  answering  this  question  give  con- 
sideration to  the  proper  manner  of  collecting  through 
the  courts,  i.  e.,  by  an  action  on  the  note  or  on  the 
account,  also  the  possibility  of  a  note  becoming  lost 
or  mislaid  if  it  is  not  represented  in  the  bills  re- 
ceivable account.  (See  "Accounting  Principles.") 
Of  what  importance  is  a  careful  examination 
and  comparison  of  the  inventory  at  the  beginning  of 
the  period  and  the  one  at  the  end  of  the  period? 

300.  Explain   the  manner  of  treating  premiums 
and  discounts  on  bonds  sold.     How  should  premium 
received  on  an  issue  of  capital  stock  be  treated?     (See 
"Accounting  Principles.")     May  this  premium  be  re- 
turned to  the  stockholders  as  a  dividend? 

301.  Mention  the  principal  points  in  the  audit  of 
a  branch  office  or  of  a  number  of  them. 

302.  Of  what  importance  is  the  careful  distinc- 
tion between  capital  and  revenue  expenditures?  What 
is  the  most  practical   manner  of  determining  just 
what  amounts  may  be  properly  charged  to  capital? 

303.  What  treatment   would  you   suggest   for   a 
series  of  expenditures  extending  over   a  period   of 
say  six  months,  all  relating  to  the  construction  of  a 
particular  building,  it  being  undesirable  to  charge 
items  to  capital  accounts  unless  they  represent  some 
particular  addition  to  the  owner's  property?  Assume 
a  purchase  of  machinery  billed  at  |5,000.00,  terms 
2% — 10  days  and  paid  for  within  the  discount  period. 
Upon  what  amount  would  depreciation  be  computed, 
$5,000.00  or  |4,900.00?     Is  it  proper  to  allow  the 
availability   of   money   at   the   time   of  purchase   to 
affect  future  charges  for  the  use  of  the  property  that 
is  being  consumed  through  operations? 

304.  Is  a  concern  justified  in  assuming  a  profit 


AUDITING  THEORY  AND  PRACTICE— Montgomery        35 

on  the  construction  of  one  of  their  buildings  by  their 
own  force,  when  at  would  have  cost  more  had  it 
been  done  by  others?  (See  "Accounting  Principles.") 

305.  May  freight,  labor,  etc.,  be  included  in  the 
capitalized  value  of  machinery?    What  consideration 
is  required  in  connection  with  notes  payable  and  how 
should  they  be  handled?    What  suggestions  can  you 
make  in  regard  to  partner's  withdrawals?    May  divi- 
dends be  declared  of  a  past  date? 

306.  May  the  directors  be  compelled  to  pay  divi- 
dends?   In  the  apportionment  of  a  decedent's  estate, 
is  a  stock  dividend  corpus  or  income? 

307.  What   consideration,    if   any,    do   the   stock 
ledger  and  stock  certificates  require?    What  is  said 
about  bonds  and  coupons  and  their  treatment  when 
cancelled  ? 

308.  Should  a  reserve  be  set  aside  to  provide  for 
the  Federal  corporation  tax?    State  the  auditor's  duty 
in  connection  Avith  office  systems. 

309.  What  are  the  essentials  of  a  desirable  filing 
system  ? 

311.     Suggest  a  few  features  of  a  desirable  system 
for  handling  stores. 

313.  How  would  you  proceed  to  test  the  accuracy 
of  stock?  Does  any  advantage  accrue  from  keeping  the 
sales,  purchases  and  inventories  of  various  classes  of 
goods  separate? 

314.  Explain  the  purposes  and  mention  the  ad- 
vantages of  controlling  accounts.     Mention  a  few  of 
the  advantages  possessed  by  columnar  ledgers. 

315.  To  what  extent  may  an  auditor  criticize  the 
efficiency  of  an  organization? 


36  GUIDE   TO  THE   STUDY  OF  AUDITING 

CHAPTER  XXI. 

DEPRECIATION. 

317.  Distinguish  between  fluctuation  and  depre- 
ciation.    Define  depreciation. 

318.  Should  the  allowances  for  depreciation  vary 
in  different  years? 

319.  Mention  a  few  of  the  causes  of  depreciation. 

320.  What  is  said  of  repairs  and  maintenance? 
Explain  the  various  methods  of  caring  for  deprecia- 
tion.    ( See  "Accounting  Principles." ) 

321.  What  is  the  effect  of  the  fixed  percentage 
method  of  charging  depreciation : 

(a)  On  a  flat  basis? 

(b)  On  a  reducing  scale? 

What  advantage  or  disadvantage    does    the   sinking 
fund  method  possess? 

325.  Is  a  dividend  illegal  if  it  requires  the  entire 
surplus  and  if  no  provision  has  been  made  for  de- 
preciation?     WThy?     Is    a    charge    for    depreciation 
based  on  the  amount  of  operating  revenue  proper? 

326.  Should   interest  on   a  sinking  fund   be  al- 
lowed to  affect  the  amount  charged  against  revenue 
during  the  life  of  an  asset?    (See  "Income  on  Reserve 
Investments" — "Accounting  Principles.")     The  table 
given  shows  exceptionally  large  charges  to  revenue 
during  the  first  years  of  the  existence  of  the  asset  in 
the  case  of  the  percentage  based  on  diminishing  val- 
ues.   Under  what  conditions  does  this  plan  of  allow- 
ing for  depreciation  prove  desirable?     Is  a  sum  set 
aside  proportionate  to  production,  a  reserve  for  de- 
preciation or  a  reserve  for  renewals? 

327.  What  effect  does  the  probable  exhaustion  of 
the  material  upon  which  to  work,  have  on  the  rate 


AUDITING  THEORY  AND  PRACTICE— Montgomery        37 

of  depreciation?  Does  the  existence  of  a  sinking  fund 
operated  in  connection  with  a  bond  issue  obviate  the 
necessity  of  providing  for  depreciation? 

328.  Is  it  desirable  to  invest  the  amount  of  a  de- 
preciation reserve  and  what  is  the  effect  of  such  a 
procedure? 

331.  Which  is  preferable,  a  reserve  for  deprecia- 
tion, a  reserve  for  obsolescence  or  a  reserve  for  con- 
tingencies to  provide  for  obsolescence  of  machinery? 
Under  what  condition  does  land  depreciate? 

332.  How   does   the   fluctuation    of   land   values 
affect  the  charge  for  depreciation? 

333.  What  is  the  approximate  life  of  different 
classes  of  buildings?    Explain  the  manner  of  treating 
premium  paid  for  a  lease.    Need  any  consideration  be 
given  the  possibility  of  loss  from  damages  to  leased 
property?     If  so,  what?     Is  the  plan  of  writing  off 
equal  portions  of  the  purchase  price  of  a  lease  each 
year  theoretically  correct?    Why? 

334.  What  rate  and  plan  of  depreciation  is  usu- 
ally used  in  connection  with  machinery  and  equip- 
ment?   Of  what  advantage  is  an  equipment  ledger? 

336.  What  treatment  should  be  given  small  tools? 
How  should  furniture  and  fixtures  be  treated  in  the 
accounts?    W'hat  effect  does  the  fact  that  fixtures  are 
on  leased  property  have  on  the  annual  charges  for 
depreciation?    What  treatment  on  the  books  should  be 
accorded  horses? 

337.  What  do  you  believe  to  be  a  fair  rate  of 
depreciation  on  automobiles?    How  would  you  treat 
the  depreciation  on  ships?    What  is  the  proper  meth- 
od of  handling  accounts  representing  patents,  giving 
consideration  both  to    absolute    ownership    and    to 
leases?    May  a  leased  patent  be  properly  placed  on 


38  GUIDE   TO   THE   STUDY  OF  AUDITING 

the  books  in  excess  of  actual  cost?    Need  a  different 
treatment  be  given  copyrights?    If  so,  what? 

338.  What  is  a  wasting  asset?  Wherein  does  the 
depreciation  of  mines  differ  from  the  depreciation  of 
machinery?  (See  "Accounting  Principles.")  Is  it 
necessary  to  allow  for  the  depletion  of  a  mine?  What 
objections  are  there  to  providing  for  such  depletion? 
How  does  the  limited  period  of  operating,  the  possi- 
bility of  working  out  a  section  at  a  time,  and  the  com- 
parative ease  of  cruising  affect  the  relative  treatment 
of  timber  lands? 


CHAPTER  XXII. 
CORPORATION  TAX  LAW  AND  DEPRECIATION. 

342.  What  is  the  substance  and  the  effect  of  the 
decision  in  the  case:     The    United    States    vs.    The 
Nipissing  Mines  Co.? 

343.  Need  the  depreciation  actually  be  given  ef- 
fect on  the  books? 

344.  Upon  what  is  the  deduction  for  depreciation 
based?    How  should  a  fluctuation  in  the  value  of  real 
estate  be  treated? 

345.  How  should  the  net  income  on  an  uncom- 
pleted contract  be   determined?     Discuss  fully  the 
treatment  of  minerals,  etc.,  in  connection  with  the 
corporation  tax  returns. 

CHAPTER  XXIII. 

SPECIAL  POINTS  IN  DIFFERENT  CLASSES  OF  AUDITS — 

FINANCIAL. 

349.     What  is  said  in  reference  to  the  examination 
of  banks? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        39 

352.  Mention   a  few  of  the   principal   points   in 
the  audit  of  a  bank?    How  would  you  proceed  to  ver- 
ify the  cash  and  securities? 

353.  Of  what  value  is  a  clearing  house  confirma- 
tion?     How   may   the  accounts  with  correspondents 
be  used  to  conceal  fraud?    What  attention  should  de- 
mand notes  receive? 

354.  How    would    you    verify    the    certificate    of 
deposit  and  the  certified  check  accounts?    How  may 
stock  certificates  be  used  fraudulently?     Outline  the 
auditor's  procedure  in  verifying  the  accounts  with 
depositors. 

355.  What  special  attention  should  be  given  in- 
active accounts?     What  information  would  you  ex- 
pect to  secure  by  a  comparison  of  the  individual  de- 
posits in  a  pass  book  with  the  entries  in  the  ledger? 
Discuss  the  verification  of  income. 

356.  Mention  a  few  of  the  features  of  a  good  sys- 
tem of  internal  check.     What  should  the  auditor's 
report  contain? 

357.  Outline  a  few  of  the  most  usual  plans  of 
covering  shortages. 

359.  What  are  the  general  points  to  be  covered 
in  an  examination  made  by  a  directors'  committee, 
as  outlined  by  the  Comptroller  of  Currency? 

360.  What  are  the  essential  features  of  a  savings 
bank  audit? 

361.  What  privileges  are  allowed  trust  companies 
that  are  not  allowed  national  banks? 

362.  Mention  a  few  of  the  departments  conducted 
by  a  trust  company  that  are  not  conducted  by  a 
national  bank.    To  what  degree  should  the  auditor  at- 
tempt to  check  the  transactions  occurring  during  the 
audit  period? 


40  GUIDE  TO  THE   STUDY  OP  AUDITING 

363.  What  items  require  special  attention  in  the 
audit  of  an  investment  company? 

364.  What  is  the  accepted  rule  in   determining 
the  net  profit  of  an  investment  company?     To  what 
account  should  the  difference  between  the  market 
values  and  cost  price  of  investments  be  charged  if  a 
decrease  in  value  has  resulted?    How  should  the  ac- 
count be  treated  in  the  balance  sheet?    If  a  favorable 
fluctuation  has  occurred,  how  should  it  be  treated? 
Why  is  it  desirable  to  distinguish  between  bona  fide 
investment  companies  and  speculative  securities  com- 
panies? 

365.  Is  it  wise  to  assume  a  profit  where  a  simple 
exchange  of  stock  has  occurred?    Why?    What  is  the 
meaning  of  "wash  sales"? 

366.  Mention  a  few  of  the  books  found  in  a  stock 
broker's  office  and  explain  their  use. 

369.  How  would  you  verify  the  cash  or  securities? 
How  would  the  accounts  with  customers  be  verified? 

370.  What  attention  should  be  given  margins?    Is 
it  within  the  auditor's  duty  to  verify  all  charges  for 
interest  or  commission?    What  constitutes  the  most 
satisfactory  audit  of  a  broker's  accounts? 

371.  How   may    dividends   be   diverted   into    im- 
proper channels?     Explain  the  method  employed  by 
the  cashier  in  abstracting  cash  as  mentioned  on  page 
371. 

372.  Outline  the  usual   plan   of  organization   of 
a  building  and   loan   association;   also   explain   the 
method  of  operation.     Wherein  does  the  payment  of 
the  capital  stock  of  such  an  association  differ  from 
that  of  an  ordinary  company? 

373.  What  are  the  principal  sources  of  income  of 
building  and  loan  associations?    How  would  you  pro- 
ceed to  verify  the  income  of  the  association? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        41 

374.  How  would  you  proceed  to  verify  the  amount 
of  capital  stock  outstanding? 

375.  Explain  the  most  desirable  plan  of  appor- 
tioning the  earnings  of  the  association.     Upon  what 
should  the  profits  be  distributed — the  average  book 
value  of  each  share  or  the  amount  of  dues  paid  in? 

376.  Refer  to  the  form  on  page  376  and  comment 
on  the  order  of  the  assets  shown.     Do  the  profits  of 
the  year  properly  constitute  a  portion  of  the  capital 
stock? 

CHAPTER  XXIV. 

SPECIAL  POINTS  IN  DIFFERENT  CLASSES  OF  AUDITS 
( Continued )  — INSURANCE  COMPANIES. 

378.  Under   what   laws   do   insurance  companies 
usually  incorporate?    Who  is  authorized  to  audit  the 
accounts  of  insurance  companies  and  what  is  the  ob- 
ject of  such  an  audit? 

379.  What  are  the  principal  sources  of  income  of 
a  fire  insurance  company  and  how  would  you  pro- 
ceed to  verify  their  receipt?    In  addition  to  the  ver- 
ification of  the  income,  what  points  should  be  given 
consideration  by  the  auditor? 

380.  Explain    the    manner    of   manipulating   the 
accounts  as  employed  by  Walker  and  Bradford? 

381.  Mention  a  few  of  the  most  important  liabil- 
ities of  a  fire  insurance  company  and  explain  how 
an  auditor  would  proceed  to  verify  them? 

382.  In  what  respects  does  the  audit  of  a  life 
insurance  company  differ  from  that  of  a  fire  insur- 
ance company?    What  attention  should  be  given  the 
investments  of  the  life  insurance  company?     How 
should  loans  to  policy  holders  be  verified?    Ordinarily 
may  a  life  insurance  company  invest  in  real  estate? 


42  GUIDE   TO  THE    STUDY   OF  AUDITING 

Mention  other  sources  of  income  of  a  life  insurance 
company  and  explain  the  method  of  verification. 

383.  How  is  the  insurance  reserve  of  a  life  in- 
surance company  calculated? 

384.  Is  it  considered  proper  to  include  real  estate 
at  its  appraised  valuation  in  a  balance  sheet,  and 
if  so,  what  is  the  final  disposition  of  the  amount 
by   which   it   is   increased   or   decreased   from   year 
to  year?    What  should  be  contained  in  the  account 
"Syndicate  Subscriptions"? 

385.  What  criticisms  can  you  offer  as  to  the  com- 
parative arrangement  of  the  assets  and  liabilities? 

386.  Is  the  item  "gain  in  market  values"  properly 
included  in  the  income  account  without  also  giving 
effect  to  some  compensating  item  to  offset  its  effect 
until  the  profit  anticipated  is  actually  realized?     Is 
there  an  account  in  this  statement  which  contains  the 
offsetting  entry  and  if  so,  which  one? 

390.  What  should  be  the  procedure  of  the  audi- 
tor in  verifying  expenditures  for  wages?    What  con- 
sideration do  freight  and  material  require  on  the  part 
of  the  auditor?    Explain  the  different  plans  of  pro- 
viding for  depreciation  of  manufacturing  plants. 

391.  Under  what  conditions  is  it  proper  to  set 
up  a   "Beserve   for   Repairs   and   Renewals"   deter- 
mined by  the  production  method,  and  does  such  a 
reserve  eliminate  the  necessity  of  providing  a  reserve 
for  depreciation?    Mention  a  source  of  income  often 
found  in  the  accounts  of  manufacturing  companies 
owning  the  homes  of  their  employees  and  explain  the 
manner  of  verification.     How  would  you  recommend 
that  rentals  secured  through  sub-letting  a  portion  of 
leased  premiums  be  handled?    Of  what  value  to  the 
auditor  are  cost  and  stock  accounts  in  a  manufactur- 
ing plant? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        43 

392.  What  is   gained  by   showing   the  property, 
acquired  during  any  one  year,  in  an  account  sepa- 
rate   from    the    account    representing    property    on 
hand  at  the  beginning  of  the  year?     In  this  balance 
sheet,  for  the  purpose  of  comparison  and  the  con- 
sideration of  relative  values  are  "Goodwill"  and  "Cap- 
ital Stock"  properly  placed?    Why?    Are  the  current 
items  properly  placed  for  comparison?    Are  the  items 
under    the    caption    "Current    Assets"    arranged    in 
proper  order?     Why?     Should  bonds  and  stock  of 
other  companies  be  included  under  the  caption  "Cur- 
rent Assets"?    Why?    Is  it  proper  to  include  accrued 
items  under  the  caption  "Current  Liabilities,"  and  if 
so,  why  should  the  deferred  charges  to  operation  be 
shown  under  a  separate  heading  among  the  assets? 
What  excuse  is  there  for  showing  "Bonded  Debt"  first 
among  the  liabilities? 

393.  Wherein   does  the  treatment   of  capital   in 
the  balance  sheet  differ  from  the  usual  American 
form?      Where  should  contingent  liabilities  be  placed 
in  a  balance  sheet? 

394.  Under  what  conditions,  and  why,  is  it  de- 
sirable to  keep  the  sales  account  so  it  will  show  not 
only  values,  but  quantities  as  well?     Mention  a  few 
of  the  special  features  of  publishers'  accounts  and 
explain  how  they  should  be  treated  by  the  auditor. 

395.  How  should  royalties  be  handled?    Are  they 
an  element  of  cost?    To  what  extent  should  the  audi- 
tor inquire  into  inventories? 

396.  Discuss    the    valuation    of    plates,    linotype 
metal,  drawings  and    electros    in    connection    with 
the  inventories. 

397.  Do  the  accounts  receivable  require  special 
consideration  and  if  so,  what?    How  would  you  deal 
with  postage? 


44  GUIDE   TO  THE   STUDY  OF   AUDITING 

398.  Mention  the  principal  sources  of  revenue  of 
a  magazine  or  newspaper  publisher  and  explain  how 
the  auditor  should  proceed  in  their  verification. 

399.  What    precaution    would    you    take    before 
certifying  to  the  circulation  of  a  paper? 

400.  How  should  subscriptions  be  handled  in  the 
accounts  so   that  each  month  will  show  a  proper 
credit  for  the  amount  earned? 

402.  Give   a   careful    outline   of   the   work   that 
should  be  done  by  an  auditor  in  verifying  brewers' 
accounts,  giving  consideration  to  containers,  collec- 
tions, investments  in  saloons,  advances  and  contin- 
gent liabilities. 

403.  What  advantage  would  accrue  from  an  in- 
spection of  a  mine  by  an  auditor  who  expects  to  pre- 
pare a  report  on  the  financial  result  of  its  operations? 
A  mining  company  may  receive  income  from  coal 
sales,  blacksmithing,  auxiliary  stores,  rentals  of  prop- 
erty, and  compensation  for  use  of  cars.     How  would 
you  verify  these?    Discuss  the  treatment  of  accounts 
covering  royalties  paid  in  advance  to  be  recouped 
from  future  workings.     ( See  Dicksee's  "Advanced  Ac- 
counting.") 

404.  How  should  the  various  assets  be  valued  for 
inventory  purposes? 

405.  Is  it  necessary  for  a  company  working  a 
wasting  asset  such  as  a  mine  or  quarry  to  provide  for 
the  exhaustion  of  the  property?    Why?     (See  "Ac- 
counting    Principles.")       What     consideration     do 
mortgages  require  on  the  part  of  the  auditor? 

406.  Give   an    outline   of   what   your    procedure 
would  be  in  the  audit  of  a  gold  mining  company. 

407.  Mention  a  few  of  the  possible  frauds  in  a 
wholesale  grocery  and  explain  how  you  would  pro- 
ceed to  detect  them. 


AUDITING  THEORY  AND  PRACTICE— Montgomery        45 

408.  What    details    should    be    included    in    the 
trading  statements  of  such  a  firm?     How  should  an 
auditor  proceed  to  verify  the  sales  of  a  retail  mer- 
chant? 

409.  Explain  how  sales  to  employees  should  be 
treated.    What  plan  would  you  suggest  for  keeping 
"tab"  on  stock? 

410.  Do  credit  memoranda  require  special   con- 
sideration,  and   if  so,   how  would  you   recommend 
that  they  be  treated? 

411.  What  is  the  auditor's  duty  in  regard  to  cash 
discounts  in  a  department  store?     How  would  you 
verify  the  payrolls  and  other  items  of  expense  in  a 
department  store? 

412.  Outline    a   desirable    and    practicable    plan 
of  accounts  showing  the  operations  of  each  depart- 
ment.     In  the  preparation  of  reports  showing  the 
operation  of  a  department  store,  what  information 
should  be  disclosed? 

413.  Explain   how  you  would  proceed  to  value 
notes  and  accounts  receivable  held  by  a  department 
store.     Need  any  special  consideration  be  given  in- 
ventories?    If  so,  how  would  you  deal  with  each 
special  feature?  Mention  the  most  important  features 
of  the  audit  of  an  automobile  dealer's  accounts  and 
explain  how  you  would  deal  with  each. 

416.  A  firm  having  several  branches  maintains 
an  account  with  each  branch  in  the  ledger  and 
charges  to  such  account  all  goods  sent  to  agents  for 
stock.  When  stock  is  taken  the  balance  of  each 
branch  account  is  treated  as  ordinary  accounts  re- 
ceivable and  is  included  in  the  general  debts  owing 
to  the  firm.  If  you  see  any  objections  to  this  method, 
state  them  and  say  how  you  would  handle  the 
accounts.  Explain  how  cash  should  be  treated  at  a 


46  GUIDE   TO   THE    STUDY   OF   AUDITING 

branch  office.  To  what  extent  should  an  executive  office 
be  informed  of  the  individual  transactions  of  a 
branch? 

417.  Assuming  that  goods  are  billed  to  a  branch 
at  20%   in   excess  of  cost,  what  entries  should  be 
made  on  the  books  of  the  executive  office  to  remove 
the  excess  for  the  purpose  of  inventories?     Explain 
how    the    book    values    of    various    assets    of    for- 
eign    branches     should     be     treated     to     facilitate 
the    preparation     of    consolidated    balance    sheets, 
giving    consideration    to    the    treatment    of    fixed 
assets,  current  assets  and  remittances.      (See  Dick- 
see's  "Advanced  Accounting." ) 

CHAPTER  XXV. 

SPECIAL  POINTS  IN  DIFFERENT  CLASSES  OF  AUDITS 
(Continued) — PUBLIC  UTILITIES. 

418.  Give  a  brief  outline  of  the  powers  and  duties 
of  a  Public  Service  Commission. 

420.  Discuss  the  importance  of  making  allowance 
for  depreciation   in   the  accounts  of  transportation 
companies.   Should  a  distinction  be  made  between  the 
profit  of  a  public  utility  from  the  viewpoint  of  the 
general  community  and  the  profits  earned  from  the 
point  of  view  of  the  stockholders?     If  so,  what  dif- 
ferences v  would  exist? 

421.  What  items  would  you  classify  as  expenses 
for  the  purpose  of  a  published  statement  and  how 
would  you  arrive  at  the  net  earnings?     How  would 
you  deal  with  items  not  directly  traceable  to  the  oper- 
ation of  the  utility? 

422.  In  the  audit  of  a  public  utility,  how  would 
you    determine    which    expenditures    do    or    do    not 
constitute  a  proper  charge  to  revenue? 


AUDITING  THEORY  AND  PRACTICE — Montgomery        47 

423.  In  the  case  of  a  substitution  of  one  asset 
for  another,   what  entries   should   be   made  on   the 
books  of  account? 

424.  Do  gross  earnings  from  by-products  consti- 
tute an  item  of  revenue  or  are  they  a  reduction  of  the 
cost  of  manufacture?    Is  there  any  reason  why  taxes 
should  not  be  included  in  the  cost  of  the  product  or 
apportioned  under  the  various  subdivisions  of  Ex- 
pense?     Is    the    expense    of    manufacture    properly 
stated  if  it  does  not  include  a  charge  for  insurance 
and  depreciation,  or  either  of  them? 

425.  What  should  a  valuation  of  the  properties 
of  a  public  utility  include? 

426.  Outline  a  desirable  method  of  procedure  in 
the  appraisal  of  a  public  utility. 

427  Mention  a  few  items  of  expense  which  may 
properly  be  capitalized  as  "Development  Charges." 
How  should  the  discount  on  bonds  sold  be  treated  in 
the  books  of  a  steam  railroad? 

428.  Mention  a  few  of  the  sources  of  income  of 
a  steam  railroad  and  explain  how  you  would  pro- 
ceed in  its  verification. 

430.  What  possible  technical    errors    should    the 
auditor  guard  against? 

431.  Mention  a  few  of  the  special  features  of  an 
audit  of  the  accounts  of  a  shipping  company  and 
explain  how  they  should  be  dealt  with. 

432.  Explain  how  an  insurance  fund  should  be 
operated  and  discuss   the   advisability   of   carrying 
forward  a  deficit  in  the  account  from  year  to  year. 

433.  What  is  the  most  accepted  classification  of 
the  accounts  of  an  electric  railway?  Mention  the  prin- 
cipal sources  of  income  of  an  electric  railway  and 
explain  how  you  would  proceed  to  verify  them. 


48  GUIDE   TO  THE   STUDY  OP  AUDITING 

434.  How  would  you  verify  the  pay  rolls?    What 
advantage  accrues   from    issuing   tickets   under   the 
serial  plan? 

435.  In  the  case  of  a  street  railway  which  allows 
its  conductors   to  sell  tickets   covering  transporta- 
tion for  ten  and  twenty-five  rides  at  a  lower  rate 
than   it  demands   for   cash   fares,   how  would   you 
apportion  the  revenue  so  received,  bearing  in  mind 
that  at  the  end  of  each  month  many  tickets  remain 
unredeemed?  Of  what  value  is  a  record  of  construction 
and  equipment  costs  and  how  should  such  a  record 
be  operated? 

436.  Suggest  a    term  for  use  instead  of  "Depre- 
ciation."   Combat  the  argument  that  a  reserve  for  de- 
preciation is  unnecessary  owing  to  a  rapidly  increas- 
ing value  of  the  franchises.    Discuss  the  treatment  of 
so-called  reconstruction  expenditures,  giving  consider- 
ation to  various  conditions  which  affect  their  dispo- 
sition. 

437.  A  company  has  purchased  certain  properties 
which  are  found  to  be  in  a  run  down  condition  and 
a  considerable  expenditure  is  necessary  to  bring  them 
into  efficient  operation.    Should  such  an  expenditure 
be  capitalized?     What  disposition  is  suggested  for 
expenditures  which  do  not  increase  earnings  nor  de- 
crease operation  expenses? 

438.  What  should  be  the  auditor's  procedure  in 
determining  the  liability  existing  on  unsettled  dam- 
age claims?  Give  a  short  explanation  of  the  operation 
of  a  reserve  for  accidents. 

439.  How  should  an  auditor  proceed  to  verify  the 
income  of  a  taxi  cab  company?    What  are  the  salient 
features  of  such  a  verification? 

441.     The  forms  given  herewith  seem  to  be  more 
free  from  technical  inaccuracies  than  those  usually 


AUDITING  THEORY  AND  PRACTICE— Montgomery        49 

published.  The  student  will  do  well  to  notice  care- 
fully the  grouping  of  the  items  and  their  location  in 
the  forms.  Notice  also  the  additional  column  pro- 
vided for  comparative  purposes  and,  on  pages  442-443, 
the  ease  with  which  the  current  assets  and  liabilities 
may  be  compared  as  well  as  the  fixed  assets  and  fixed 
liabilities ;  also  the  placing  of  goodwill  so  that  it  may 
be  mentally  deducted  from  the  capital  and  surplus  to 
determine  the  net  value  of  tangible  assets. 

445.  What  difference  exists  between  the  receipt  of 
revenues  of  a  street  railway  and  of  an  electric  light 
and  power  company  and  how  does  this  affect  the  audi- 
tor's work?    Rule  up  a  tabular  form  of  customers'  led- 
ger for  an  electric  light  and  power  company  illustrat- 
ing the  use  of  various  widths  of  sheets   in    the   same 
book. 

446.  What  special   attention   should   an   auditor 
give  to  the  sales  of  appliances  of  electric  companies? 

447.  What  is  said  of  the  depreciation  rates  for  elec- 
trical equipment?     Mention  the  most  important  fea- 
tures of  a  gas  company  audit  and  explain  how  you 
would  deal  with  each. 

449.  Wherein  do  the  charges  for  service  of  a  water 
company  differ  from  those  of  gas  or  electric  com- 
panies and  how  does  this  affect  the  auditor's  work? 

450.  What  are  the  principal  items  of  expense  of 
a  telephone  company? 

451.  Mention  the  principal  sources  of  income  of  a 
telephone  company.  What  are  the  principal  points,  in 
the  audit  of  a  telephone  company,  that  requires  the  at- 
tention of  the  auditor  and  how  should  he  deal  with 
each? 

452.  Draft  a  tabular  form  of  customers'  ledger  for 
the  use  of  a  telephone  company  and  explain  how  it 


50  GUIDE   TO   THE   STUDY  OF   AUDITING 

should  be  operated  in  connection  with  the  general 
books. 

453.  Give  a  short  resume  of  the  instructions  of  the 
Railroad  Commission  of  Wisconsin  in  reference  to  de- 
preciation. Is  a  charge  covering  loss  through  contin- 
gencies such  as  extraordinary  storms  properly  entered 
against  the  depreciation  reserve? 


CHAPTER  XXVI. 

SPECIAL  POINTS  IN  DIFFERENT  CLASSES  OF  AUDITS — 
MUNICIPAL —  ( Continued ) . 

455.  Explain  how  the  budget  of  a  municipality  is 
prepared  and  also  the  manner  of  determining  the  tax 
rate. 

456.  Who  are  the  principal  financial  officers  of  a 
city  and  what  are  their  respective  duties? 

457.  What  are  the  principal  sources  of  revenue  of 
a  city? 

458.  Of  what  value  is  "controlled  financial  station- 
ery" and  how  is  it  used? 

459.  Mention  a  few  advantages  of  periodical  exam- 
inations of  municipalities. 

460.  How  would  the  auditor  verify  the  taxes  re- 
ceived and  receivable?    What  attention  do  assessments 
require? 

461.  Is  it  in  order  for  the  auditor  to  verify  out- 
standing accounts  by  correspondence?    What  are  the 
principal  classes  of  expenditure  of  a  city  and  how 
would  you  verify  each  class? 

462.  Tell  about  the  sinking  fund  provisions  of  most 
bond  issues  and  the  auditor's  duty  in  regard  thereto. 

463.  Give  a  list  of  the  principal  assets  and  li- 
abilities of  a  city  which  would  appear  in  the  general 
fund  balance  sheet.    What  items  constitute  the  capital 


AUDITING  THEORY  AND  PRACTICE— Montgomery        51 

account  balance  sheet?  Which  would  appear  in  the 
trust  fund  balance  sheet?  What  is  the  purpose  of  the 
appropriation  fund  accounts  and  what  does  the  fund 
balance  sheet  show? 

464.  What  does  the  unpaid  taxes  account  show? 
Is  a  reserve  for  bad  debts  necessary?     What  is  the 
purpose  of  the  stores  account  and  how  does  it  oper- 
ate?   How  are  stores,  used  for  construction  purposes, 
treated?    Why  is  a  reserve  for  stores,  etc.,  set  up  on 
the  books?    Under  what  conditions  is  a  "Temporary 
Loans"  account  necessary?  What  may  the  Capital  Ac- 
count Cash  be  used  for  and  how  is  it  obtained? 

465.  What  is  contained  in  the  assessments  receiv- 
able account?    What  does  the  Local  Improvements  in 
Progress  account  represent?    Draft  entries  necessary 
when  the  improvements  are  completed.    How  are  local 
improvements,  chargeable  against  the  city,  treated? 
What  is  said  in  reference  to  depreciation  of  properties 
of  a  municipality? 

466.  What  is  the  object  of  Special  Improvement 
Bonds?    How  is  the  Sinking  Fund  Cash  shown  in  the 
balance  sheet?  Explain  how  the  Trust  Funds  are  oper- 
ated, giving  consideration   to  each  of  the  accounts 
used. 

467.  Give  the  headings  for  a  satisfactory  classifica- 
tion of  accounts  of  a  municipality.     Into  what  two 
classes  may  the  funds  of  a  city  be  divided? 

468.  Draft  entry  necessary  to  place  the  budget  ap- 
propriation on  the  books.    How  are  the  appropriation 
accounts  treated  when  an  expenditure  is  made  or  con- 
tracted? 

469.  Explain  how  the  Available  Balance  and  the 
Unapplied  Balance  accounts  are  operated.  What  does 
the  Reserve  for  Retirement  of  Loans  in  Anticipation 
of  Collection  of  Taxes  represent? 


52  GUIDE   TO   THE   STUDY   OF  AUDITING 

470.  Explain  how  funds  raised  by  issuing  bonds 
are  treated,  telling  how  the  Reserve  for  Retirement 
of  Assessment  Bonds  account  is  operated.  Why  are 
the  accounts  "available  balance"  and  "unapplied  bal- 
ance" omitted  from  the  consolidated  balance  sheet? 
What  constitutes  the  surplus? 


CHAPTER  XXVII. 

SPECIAL  POINTS  IN   DIFFERENT  CLASSES  OF  AUDITS, 
(Continued) — EXECUTORS  AND  TRUSTEES. 

475.  What  are  the  first  steps  an  auditor  should 
take  in  auditing  the  accounts  of  an  executor?    How 
should  the  auditor  proceed  in  verifying  the  income 
from  securities  and  what  should  he  require  as  to  their 
registration? 

476.  Explain  the  steps  the  auditor  should  take  in 
verifying  the  amount  of  commission  claimed  by  the 
executor. 

477.  How  should  interests  and  rents  accrued  to  the 
date  of  testator's  decease  be  apportioned?  How  should 
profits  sustained  through  the  liquidation  of  invest- 
ments be  apportioned?    How  would  you  deal  with  (a) 
ordinary  expenses;   (b)  repairs  to  income  producing 
property;    (c)    losses  on   unauthorized  investments; 
(d)  income  derived  from  investments  in  wasting  as- 
sets;  (e)   funds  appropriated  by  the  trustee  for  his 
own  use?    How  should  premium  or  discount  on  bonds 
purchased  be  treated? 

478.  Explain  the  procedure  where  there  are  minor 
heirs. 

479.  Mention  the  most  important  points  in   the 
audit  of  an  educational  institution  and  explain  how 
you  would  deal  with  each.    Mention  the  most  impor- 


AUDITING  THEORY  AND  PRACTICE— Montgomery        53 

taut  points  in  the  audit  of  a  charitable  institution  and 
explain  how  you  would  deal  with  each. 

484.  What  is  said  of  the  audit  of  the  accounts  of 
churches? 

485.  Explain  how  you  would  audit  the  accounts 
of  a  club,  also  state  how  you  would  suggest  that  their 
transactions  be  recorded. 

487.  How  would  you  proceed  in  the  verification  of 
commission  and  fees  of  an  architect?     Explain  hov 
the  unfinished  work  of  an  architect  should  be  valued. 

488.  What  items  require  particular  attention  in 
the  audit  of  the  accounts  of  a  doctor? 

489.  Explain   how   the  accounts  of  an   attorney 
should  be  kept. 

490.  Explain   how  the  accounts  of  a  contractor 
should  be  kept.    How  would  you  deal  with  payrolls? 
Explain  how  you  would  proceed  in  the  valuation  of 
work  in  progress  for  the  purpose  of  determining  profit. 

492.  What  special   points   require   consideration 
where  there  are  a  number  of  sub-contractors?    What 
are  the  principal  points  in  the  audit  of  the  accounts  of 
a  real  estate  concern  and  how  should  the  auditor  veri- 
fy each  item? 

493.  Explain  how  the  cashier  mentioned  operated 
the  accounts  to  cover  his  defalcation. 

495.  What  are  the  books  used  by  a  land  and  de- 
velopment company,  and  explain  the  purpose  and  use 
of  each.    Give  a  short  review  of  the  work  that  should 
be  performed  by  the  auditor  in  auditing  such  a  con- 
cern. 

496.  How  would  you  proceed  in  the  audit  of  a  hotel 
and  a  restaurant? 

497.  What  points  require  special  consideration  in 
the  audit  of  an  advertising  agency  and  how  would  you 
deal  with  each? 


54  GUIDE   TO   THE   STUDY   OF  AUDITING 

498.  How  should  the  accounts  of  a  theatre  be 
kept?  Tell  how  the  auditor  should  verify  them. 

500.  What  is  said  of  the  audit  of  the  accounts  of 
a  theatrical  company? 


CHAPTER  XXVIII. 

INVESTIGATIONS. 

502.  Distinguish  between  an  audit  and  an  investi- 
gation.    Under  what  conditions  is  an  investigation 
necessary? 

503.  Mention  a  few  reasons  why  it  is  necessary 
to  retain  all  working  papers. 

505.  Explain  how  the  auditor  should  act  in  refer- 
ence to  the  assets  that  have  been  appraised. 

506.  Explain  how  the  auditor  should  deal  with  en- 
tries that  he  believes  to  be  fictitious. 

507.  Under  what  conditions  may  loose  leaf  records 
be  admitted  as  evidence?  What  is  said  about  erasures? 
What  advantages  accrue  through  retaining  all  original 
records? 

509.  Tell  how7  an  auditor  may  be  of  value  to  his 
client  in  an  examination  and  give  a  short  outline  of 
the  information  he  might  convey  with  this  purpose 
in  view. 

511.  What  period  is  usually  covered  in  an  investi- 
gation made  to  determine  the  sale  value  of  a  concern  ? 

512.  Of  what  importance  is  a  careful  report  on 
Gross  Earnings? 

514.  What  features  should   a  properly  prepared 
statement  for  a  prospective  purchaser  show? 

515.  What  are  the  more  common  methods  of  man- 
ipulating sales?    Tell  how  you  would  guard  against 
them. 


AUDITING  THEORY  AND  PRACTICE— Montgomery        55 

516.  Of  what  value  to  the  auditor  would  be  an  in- 
quiry into  the  number  of  new  accounts?    Why  would 
a  month  of  unusually  large  sales  require  special  men- 
tion in  a  report? 

517.  Explain  the  meaning  of  "turnover."      (See 
"Accounting  Principles.")     In  a  report  prepared  to 
show  the  condition  of  a  business  to  a  prospective  pur- 
chaser, how  would  you  deal  with  profits  due  to  the 
sale  of  a  portion  of  the  raw  material?    As  an  auditor, 
are  you  justified  in  charging  a  loss,  due  to  an  unfavor- 
able fluctuation  in  the  value  of  raw  material,  against 
earnings?     To  what  extent  is  the  auditor  interested 
in  the  volume  of  expenses? 

518.  The   expenditures   of   a   magazine   company 
during  the  first  years  of  its  life  are  in  the  nature  of  a 
purchase  of  goodwill.     Should  any  charge  be  made 
against  operations  to  absorb  this  expenditure?     Ex- 
plain how  the  auditor  should  deal  with  a  lease,  the 
first  term  of  which  will  shortly  expire  and  which  may 
be  renewed  at  a  considerable  increase  of  rental. 

519.  What  other  points  in  connection  with  leases 
require  attention? 

520.  In  the  sale  of  a  certain  business  it  is  decided 
to  take  over  the  stock  at  10%  below  market.    Explain 
how  this  deduction  affects  the  earnings  of  the  concern 
for  the  period  under  review. 

521.  To  what  extent  is  an  auditor  justified  in  cer- 
tifying to  future  results? 

522.  Explain  how  the  auditor  should  deal  with 
prospective  profits  due  to  increased  capacity  or  the 
ability  to  secure  cash  discounts. 

524.  In  the  case  of  a  proposed  consolidation,  of 
what  importance  is  the  attitude  of  former  owner? 

526.  What  is  said  in  reference  to  the  preparation 
of  a  new  system? 


66  GUIDE   TO  THE   STUDY  OF  AUDITING 

CHAPTER  XXIX. 

INVESTIGATIONS  ( Continued ) . 

528.  Explain  how  the  auditor  should  deal  with 
the  income  from  assets  that  are  not  to  be  taken  over 
at  the  time  of  sale. 

529.  Explain  how  you  would  deal  with  profits  due 
to:    (a)  the  sale  of  fixed  assets ;  (b)  the  appreciation 
of  assets;  (c)  insurance  or  the  collection  of  damages 
to  property  in  excess  of  actual  losses. 

530.  Would  you  give  effect  to  losses  through  de- 
falcation or  fire? 

531.  Why  is  it  necessary  to  include  a  charge  for 
management  when  determining  profits  even  though 
no  such  expenditure  has  ever  been  made.    How  would 
you  deal  with  existing  contracts  covering  the  pur- 
chase of  raw  material  in  advance  of  consumption? 

532.  Why  should  the  auditor  make  enquiries  into 
the  requirements  of  the  Public  Service  Commission? 

533.  To   what  extent   should   the  auditor   guard 
against  errors  in  the  books? 

535.  Is  a  liquidating  partner  entitled  to  compen- 
sation for  his  own  services  in  closing  out  the  concern? 
What  consideration  should  the  auditor  give  to  dis- 
counts, allowances  and  credits  for  returned  goods? 

536.  How  should  stock  be  valued  at  the  time  of  a 
transfer  of  ownership?    How  should  profits  or  losses 
on  existing  contracts  be  apportioned  between  retiring 
and  continuing  partners? 

538.  Give  a  short  resume  of  the  quotation  from  the 
paper  on  Accounting  Practice  and  Procedure. 

539.  Mention  the  most  important  features  of  in- 
terest to  bankers  in  connection  with  loans. 

542.     What  is  said  in  reference  to  an  investigation 
for  purely  credit  purposes?    In  answering  this  ques- 


AUDITING  THEORY  AND  PRACTICE— Montgomery        57 

tion  give  consideration  to  (a)  business  methods  of  bor- 
rower; (b)  causes  of  failures;  (c)  necessity  of  con- 
sidering gross  profit  on  sales;  (d)  insurance;  (e)  er- 
rors of  principle. 

549.  Give  a  short  outline  of  the  auditor's  procedure 
where  he  is  endeavoring  to  locate  a  defalcation. 

550.  Should  he  allow  the  defaulter  to  assist? 

551.  Tell  about  the  Millwall  Dock  case. 

CHAPTER  XXX. 

HOLDING  COMPANIES. 

554.  What  information  should  the  balance  sheet 
of  a  holding  company  convey? 

555.  How  should  the  excess  of  purchase  price  over 
book  value  be  dealt  with?  When  preparing  a  consoli- 
dated balance  sheet,  is  an  auditor  justified  in  includ- 
ing with  the  surplus  of  the  holding  company,  the  sur- 
plus shown  on  the  balance  sheets  of  the  subsidiary 
company?     (See  "Accounting  Principles.") 

556.  In   preparing  a  consolidated   balance   sheet 
how  should  inter-company  transactions  be  treated? 
What  is  said  in  reference  to  accounts  receivable? 

557.  Explain  how  the  net  profit  of  a  holding  com- 
pany should  be  ascertained.     (See  "Accounting  Prin- 
ciples." )    Are  profits  of  subsidiary  companies  not  dis- 
tributed as  dividends  by  the  subsidiary  company  avail- 
able for  distribution  as  dividends  on  the  stock  of  the 
holding  company? 

560.  Explain  how  interest  on  bonds  of  a  subsid- 
iary company  in  possession  of  the  holding  company 
should  be  treated  in  a  consolidated  statement. 

561.  Give  a  reason  for  including  interest  on  plant 
investment  when  preparing  comparative  statements 
of  several  subsidiary  companies. 


58  GUIDE  TO  THE   STUDY   OF   AUDITING 

CHAPTER  XXXI. 
INTEREST. 

564.  What  is  the  rule  of  applying  payments  where 
partial  payments  are  made  and  where  principal  and 
accrued  interest  are  due?     Is  there  a  different  rule 
where  the  payment  is  not  sufficient  to  cover  the  ac- 
crued interest? 

565.  What  is  the  law  in  respect  to  interest  on  a 
contract  made  in  one  place  but  payable  in  another? 
What  is  the  rule  in  regard  to  changes  in  the  law  dur- 
ing the  time  a  note  is  in  force? 

566.  What  is  the  custom  of  bankers  in  regard  to 
interest? 

567.  Wherein  does  the  custom  of  business  houses 
and  brokers  differ  from  that  of  banks? 

568.  What  is  said  in  regard  to  the  manner  of  com- 
puting the  interest  where  a  note  runs  a  certain  num- 
ber of  months  and  days? 

CHAPTER  XXXII. 

THE  LIABILITIES  OP  AUDITORS. 

571.  What  is  said  in  reference  to  increasing  the 
responsibility  of  auditors? 

573.  What  is  the  status  of  an  auditor  in  England 
and  what  are  his  rights  and  duties? 

574.  To  what  extent  is  the  auditor  liable  for  the 
accuracy  of  his  reports? 

578.  To  what  extent  is  an  auditor  responsible 
for  the  accuracy  of  inventories? 

580.  Under  what  conditions  have  the  English 
courts  held  an  auditor  responsible  for  dividends  paid 
out  of  capital? 


AUDITING  THEORY  AND  PRACTICE— Montgomery        59 

585.     In  the  case  of  the  Irish  Woolen  Co.,  upon 
what  grounds  was  the  auditor  held  responsible? 

587.  Under  what  conditions  is  an  auditor  respon- 
sible for  failure  to  detect  embezzlement? 

588.  Give  a  short  summary  of  the  text  covering 
the  liabilities  of  auditors. 


CHAPTER    XXXIII. 
THE  LIABILITIES  OF  DIRECTORS. 

593.  What  is  said  in  reference  to  the  compensa- 
tion of  directors  and  the  auditor's  duty  in  reference 
thereto? 

594.  Under  what  conditions  may  a  director  have 
access  to  the  books  of  the  company?     Give  a  short 
summary  of  the  American    Malting  Company   case 
and  the  liability  of  the  directors  thereof. 


60  GUIDE  TO  THE   STUDY  OF   AUDITING 


AUDITING  EXAMINATION  QUESTIONS 

UNIVERSITY  OF  THE  STATE  OF  NEW  YORK 

34TH  ACCOUNTANT  EXAMINATION 
GROUP  I 

1.  The  bondholders  of  a  company  are  contemplating  an  action 
against  the  directors  and   retain  you  to  obtain   the  accounting 
proof  of  their  contentions;    subsequently  the   directors  ask  you 
to  act  in  the  same  capacity  for  them;   they  profess  to  have  no 
objections  to  your  representing  both  sides.     What  would  you  do? 

2.  Explain  the  steps  you  would  take  regarding  an  asset  de- 
scribed as  "Accounts  Receivable — Suspense,"   in  the  audit  of  a 
business,  the  owners  of  which  required  a  "clean  and  unqualified 
certificate." 

3.  In  an  audit  of  a  business  the  Plant  Account  of  which  has 
been  increased  from  $100,000  to  $150,000,  what  steps  would  you 
take  regarding  this  asset  and  what  would  be  your  controlling  con- 
sideration as  to  the  propriety  of  the  $50,000  of  additions  during 
the  period  under  audit? 

4.  What  vouchers  would  you  refuse  to  accept  in  the  audit  of 
a  corporation,   even  though  such  vouchers  were   duly   approved 
by  such  of  the  officers  of  the  corporation  as  is  required  by  custom 
or  in  the  by-laws?     Give  examples  and  explain. 

5.  A  life  insurance  company  pays  lump  sum  of  $7,500  to  pur- 
chase an  agent's  interest  in  renewal  premiums.    What  is  the  cor- 
rect treatment  of  such  expenditure?     Explain  fully. 

GROUP  II 

6.  A  lead  company  issues  certificates  evidencing  the  sale  of 
and  agreement  to  deliver  on  demand  to  the  purchaser  a  certain 
number  of  pigs  of  lead  of  variable  and  unknown  weight,  at  a 
price  to  be  based  on  the  average  daily  published  quotation  of  pig 
lead  during  the  month  in  which  the  certificates  are  issued.     In 
a  certified  balance  sheet  how  would  you  treat  these  certificates? 
Explain. 

7.  In  an  audit  covering  the  year  ended  December  31,  you  dis- 
cover that  invoices  aggregating  $2,000  for  bricks  and  other  build- 
ing materials  to  be  used  in  the  construction  of  an  addition  to 
the  plant,  were  received  after  the  books  were  closed,  although 
the  materials  were  actually  received  on  December  15.     As  the 
materials  were  not  taken   into  the   inventory   and  the   invoices 
were  not  on  the  books,  would  you  require  any  adjustment?    Give 
reasons. 

8.  As  a  certified  public  accountant  auditing  the  books  of  a 
manufacturing  business  that  operated  a  supposedly  highly  devel- 
oped cost  system,  what  steps  would  you  take  regarding  inventory 
values  that  were  found  to  agree  with  the  cost  records? 

9.  You  are  instructed  to  make  an  audit,  prepare  and  certify 
a  balance  sheet  to  be  publicly  used  in  the  sale  of  additional  capital 
stock.    The  date  of  your  engagement  is  September  16,  1912.    No 


C.  P.  A.  QUESTIONS.  61 

inventory  has  been  taken  since  October  31,  1911.     What  course 
would  you  pursue? 

10.  The   Wiltshire   Life   Insurance   Company's   office   building 
has  suffered  a  total  loss  by  fire.    The  loss  stands  on  the  books  at 
$100,000  but  the  site  alone  is  known  to  be  worth  double  that 
amount.     At  the  time  of  your  audit  the   company   has   lost   in 
rentals  from   the  burned   building   $6,000   and   has   paid   $15,000 
taxes  and  expenses  incidental  to  the  removal  of  debris.     How 
would  you  have  these  items  treated?    Give  reasons. 

GROUP  III 

11.  Write  three  concise  certificates  to  a  balance  sheet,  with 
qualifications   respectively   as   to    (a)    inventory   of   merchandise 
not  taken  under  your  supervision,    Cb)    accounts   receivable  not 
verified  by  confirmation,  (c)  investment  securities  not  examined. 

12.  The  "proof"  of  the  first  teller  of  a  bank  shows  the  follow- 
ing captions: 

Debits.  (I)  Cash,  (2)  Second  Teller,  (3)  Third  Teller, 
(4)  Second  Teller  Special,  (5)  Clearing  House. 

Credits  (1)  National  Bank  Notes,  (2)  Checks  on  Bank, 
(3)  Second  Teller's  Items,  (4)  Third  Teller's 
Items,  (5)  Clearing  House. 

State  what  instructions  you  would  give  to  an  assistant  whom 
you  were  about  to  entrust  with  the  checking  of  that  proof,  im- 
mediately following  the  count  of  the  cash  and  securities  on 
hand. 

13.  You  are  retained  by  an  inventor  to  ascertain  the  accuracy 
of  the  figures  submitted  by  a  company  operating  under  his  li- 
cense.    Royalties  are  paid  on  sales;   licensee  issues  a  catalog  in 
which  the  sundry  finished  products  are  referred  to  by  numbers; 
if  the  invention  is  used  on  any  particular  product  the  letter  I 
precedes  the  code  number.     What  steps  would  you  take  to  per- 
form your  duty? 

14.  An  electric  lamp  manufacturing  company  has  charged  to 
cost  of  lamps  as  "depreciation"  one-fourth  of  the  value  of  the 
filament-filtering  machinery  acquired  a  little  more  than  one  year 
ago.     The  life  of  the  machinery  is  estimated  to  be  10  years,  but 
owing  to  discovery  by  a  competitor  of  a  new  process  of  metal 
pulling   which,   while   still   imperfect,    promises   to   revolutionize 
the  lamp  industry,  the  machinery  in  question  will  probably  be 
obsolete  within  a  period  of  three  years.     State  at  length  what 
you  would  say  concerning  the  propriety  of  making  such  a  charge 
to  cost. 

15.  The  consolidation  of  companies  A,  B.  and  C  is  under  con- 
sideration; it  is  desired  to  establish  a  comparative  statement  of 
income  for  the  three  companies  as  of  August  31,  1912.     Company 
A  closes  its  books  on  December  31;  Company  B  on  June  30;  the 
fiscal  period  of  Company  C  expired  on  August  31.    No  inventories 
have  been  taken  as  of  the  latter  date  by  A  and  B,  and  they  will 
not  be  taken.     Express  the  procedure  that  you  would  follow  in 
order  to  establish  a  satisfactory  statement. 


62  GUIDE   TO   THE   STUDY   OF  AUDITING 

UNIVERSITY  OF  THE  STATE  OF  NEW  YORK 

35TH  ACCOUNTANT  EXAMINATION 
GROUP  I 

1.  A,  engaged  in  the  jobbing  business,  enters  into  a  copart- 
nership agreement  with  B,  the  terms  of  which  are  in  substance  as 
follows:     B  is  to  share  in  the  gains  and  losses  of  the  business  at 
the  ratio  of  37M>%,  which  is  in  proportion  to  his  investment  of 
$6,000.     A  is  to  act  as  general  manager,  cashier,  etc.,  and  is  to 
render  an  accounting  to  B  at  the  end  of  every  six  months.     The 
books  are  kept  by  single  entry.    They  are  day  book,  check  book, 
provided  with  proper  columns  and  space  for  deposits,  drawings 
and  particulars,  and  a  general  ledger  kept  in  accordance  with 
the  purpose  of  single  entry.     All  moneys  received  or  paid  pass 
through  the  bank.     You  are  engaged  to  render  the  accounting  to 
B  at  the  end  of  the  first  six  months.    State  what  information  you 
would  consider  necessary  to  convey  to  B,  and  how  you  would  pro- 
ceed to  obtain  it  from  the  material  at  hand. 

2.  What  are  the  chief  points  to  which  attention   should   be 
directed  in  dealing  with  fluctuating  currency  in  the  books  of  ac- 
counts of  merchants? 

3.  An  auditor,  on  completing  an  investigation  of  the  affairs 
of  an  importing  house,  certifies  that  the  accounts  are  correct  as 
recorded  in  the  books.    Would  you  criticize  this  certification?    If 
so,  why? 

4.  An   importer   of  automobiles   receives   shipments   in   accor- 
dance with  bona  fide  orders  placed  against  six  months'  acceptances 
with  interest.     He  stores  the  merchandise  in  bonded  warehouses 
subject  to  withdrawal.     At  the  end  of  the  fiscal  period  it  is  cus- 
tomary to  omit  from  the  inventory  such  warehouse  goods  as  are 
left  and  also  the  acceptances  unpaid.     In  being  asked  to  certify 
the  statement  of  conditions  at  a  given  time,  how  would  you  deal 
with  this  state  of  facts? 

5.  A,   B   and   C   are   equal    partners,    each   having   subscribed 
$5,000  to  the  partnership.     A  pays  in  $3,000,  leaving  $2,000  still 
due  the  partnership  on  his  capital  account.    It  is  agreed  for  the 
present  that  this  $2,000  can  remain  unpaid,  provided  A  pays  in- 
terest on  same,  which  he  does.    Later  a  dispute  arises  as  to  how 
this  interest  shall  be  credited.     A  claims  that  it  should  be  in- 
cluded with  the  earnings  of  the  business,  the  profits  of  which  are 
to  be  divided  equally  among  the  three  partners.     B  and  C  claim 
that  this  interest  should  be  divided  between  them  only,  as  they 
have  fully  lived   up  to  their  obligations   under  the  partnership 
agreement,  while  A  had  only  partially  done  so.    To  what  account 
should  the  interest  on  the  deferred  payment  be  credited? 

GROUP  II 

6.  In   auditing  the   accounts   of  a   manufacturing  firm,   what 
salient  features  of  the  cost  ledger  should  receive  attention? 

7.  In   auditing  the  accounts  of  a  manufacturing   contractor, 
what  manipulations  of  the  cost  accounts  should  the  auditor  an- 
ticipate, to  guard  against  inflating  profits? 


C.  P.  A.  QUESTIONS.  63 

8.  What  common  expedient  is  resorted  to  by  manufacturing 
contractors  to  hide  their  losses  in  the  cost  ledger? 

9.  In  auditing  the  accounts  of  a  factor,  what  equitable  method 
should  the  auditor  employ  to  ascertain  the  amount  of  interest  due 
to  or  from  the  consignor  with  respect  to  the  account  sales? 

10.  What  documentary  evidence  would  you  require  to  prove 
the  acceptance  of  bills   payable   by   a   factor,   against  goods   in 
transit? 

GROUP  III  ? 

11.  What  method  would  you  adopt  to  prove  the  outstanding 
certificates  of  stock  to  be  correct  as  represented  on  the  transfer 
ledger? 

12.  The  value  of  the  lease  of  a  piece  of  property  for  20  years, 
with  privilege  of  renewal  for  a  like  period,   is  carried  on  the 
books  at  its  value  in  fee  simple.    Would  you  pass  this  unnoticed? 
If  not,  why  not? 

13.  In  the  books  of  a  manufacturing  corporation  whose  ac- 
counts you  are  investigating  for  creditors,  you  learn  from  outside 
sources  that  accounts  assigned  to  a  discount  company  have  been 
concealed.       Explain   how   this   may   have   been   done    and    the 
methods  you  would  pursue  to  detect  it. 

14.  Three  corporations  are  to  be  merged.     In  examining  the 
records  of   Corporation   B   formed   three   years   previously   with 
an  authorized  capitalization  of  $250,000,  you  find  the  entire  cap- 
ital stock  carried  on  the  books  as  fully  paid  in.     The  facts  you 
ascertain  are  as  follows: 

There  are  three  directors,  X,  Y  and  Z,  composing  all  the  sub- 
scribers to  the  stock.  The  payments  have  been  received  at  a 
directors'  meeting  with  all  present.  X  subscribed  for  $100,000 
worth  of  stock  and  paid  all  in  cash;  Y  subscribed  for  $75,000 
worth  of  stock  and  paid  $50,000  in  cash  and  a  note  of  $25,000  on 
demand;  Z  subscribed  for  $75,000  worth  of  stock  and  paid  $25,000 
in  cash  and  a  note  of  $50,000  on  demand. 

These  notes  are  carried  among  the  assets  and  are  still  unpaid 
at  the  time  of  your  examination,  no  interest  having  been  col- 
lected. Y  and  Z  cannot  make  good.  In  preparing  a  report  on 
this  state  of  facts  what  recommendations  would  you  make  and 
why? 

15.  In  auditing  the  books  of  a  concern  you  detect  the  fol- 
lowing: 

A  customer  paid  $100  in  currency  on  account  of  a  debt  and 
returned  $10  worth  of  merchandise.  The  entry  in  the  cashbook 
records  a  receipt  of  only  $90  and  the  return  book  a  return  of  $20. 
The  money  not  properly  accounted  for  was  taken  by  the  book- 
keeper. In  reporting  these  facts  state  where  in  this  transaction 
you  find  a  defalcation,  a  fraud  committed  or  an  embezzlement. 


or 


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